KIRBY McINE 3ZNEY & SQUIRE, ir PRoger W. Kirby, Esq.Alice McInerney, Esq. 11VAndrea Bierstein, Esq.830 Third Avenue 3 \994New York, NY 10022 ,ck-1A 1(212) 317-2300

AT 8:30 ........ ...........4111.1.0n1,10K ,

Lead Counsel for the PRIDES class

UNITED STATES DISTRICT COURTFOR THE DISTRICT OF NEW JERSEY

IN RE CENDANT CORPORATION Master File No.SECURITIES LITIGATION CV-98-2819 (WHW)

This Document Relates To: PRIDES JURY TRIALclaims DEMANDED

SECOND AMENDED AND CONSOLIDATED COMPLAINTRESPECTING THE PRIDES CLAIMS

April 5, 1999

•

TABLE OF CONTENTS

I. JURISDICTION AND VENUE 1

ALLEGATIONS RELATING TO THE SECURITIES ACT CLAIMS 2

II. INTRODUCTION 2

III. THE PARTIES 5

PLAINTIFFS 5

DEFENDANTS 6

A. CENDANT DEFENDANTS 6

B. THE INDIVIDUAL DEFENDANTS 7

1. Inside Directors of Cendant 7

a. Former CUC Inside Directors 7

b. Former HFS Inside Directors 9

2. Outside Directors of Cendant 1 1

a. Former Members of CUC Audit Committee 1 1

b. Certain Other Outside Directors 1 2

3. Other Individual Cendant Defendants 1 3

C. ACCOUNTANT DEFENDANT 1 3

D. UNDERWRITER DEFENDANTS 1 5

E. CERTAIN NON-PARTIES: OTHER CENDANT OFFICERS ANDEMPL OYEES 1 8

IV. BACKGROUND 2 1

A. CUC MERGES WITH HFS AND CHANGES NAME TO CENDANT 21

B. THE PRIDES OFFERING AND SURROUNDING CIRCUMSTANCES .. . 22

V. CLAIMS UNDER SECTIONS 11 AND 12(a)(2) OF THE SECURITIES ACT 25

A. THE MATERIALLY FALSE AND MISLEADING REGISTRATIONSTATEMENT 25

B. CENDANT'S ADMISSIONS AS TO THE FALSITY OF THE FINANCIALINFORMATION CONTAINED IN THE REGISTRATION STATEMENT ANDPROSPECTUS 30

C. THE NATURE OF THE ACCOUNTING IRREGULARITIES IN CENDANT'SFINANCIAL STATEMENTS 38

1. Topside Adjustments to Quarterly Results 38

2. Irregularities Involving Utilization of Merger Reserves 39

3. Irregularities in Connection with Revenue Recognition 40

4. Irregularities Concerning the Membership Cancellation Reserve 41

D. VIOLATIONS OF GAAP 41

1. Internal Control Deficiencies Cited in Audit Committee Report 46

2. The Financial Reporting Process 47

3. The Budget and Planning Process 48

4. The Internal Audit Function 49

5. Information for Management 49

E. THE INDIVIDUAL DEFENDANTS FAILED TO EXERCISE REASONABLECARE IN THE PREPARATION AND DISSEMINATION OF THEREGISTRATION STATEMENT AND PROSPECTUS 50

1. Cendant Directors Who Were Former CUC Insiders 52

2. Cendant Directors Who Were Members of the CUC AuditCommittee 55

3. Cendant Directors Who Were Former HFS Directors and Officers . .. . 56

F. THE NATURE OF THE UNDERWRITER DEFENDANTS'0 WRONGDOING 61

G. THE NATURE OF ERNST & YOUNG'S WRONGDOING 63

VI. CLAIMS UNDER THE SECURITIES ACT OF 1933 78

FIRST CLAIM FOR RELIEF(Against the Cendant Defendants forViolations of Section 11 of the Securities Act) 78

SECOND CLAIM FOR RELIEF(Against the Individual Defendantsfor Violations of Section 11 of the Securities Act) 80

THIRD CLAIM FOR RELIEF(Against Ernst & Young For Violations ofSection 11 of the Securities Act) 81

FOURTH CLAIM FOR RELIEF(Against the Underwriter Defendants

0 For Violations of Section 11 of the Securities Act) 83

FIFTH CLAIM FOR RELIEF(Against the Cendant Defendants and the UnderwriterDefendants For Violations of Section 12(a)(2) of the Securities Act) 84

SIXTH CLAIM FOR RELIEF(Against the Individual Defendantsfor Violation of Section 15 of the Securities Act) 86

ALLEGATIONS RELATING TO THE EXCHANGE ACT CLAIMS 86

VII. INTRODUCTION TO THE EXCHANGE ACT CLAIMS 86

A. THE CONTINUING FRAUD: REPRESENTATIONS MADE ON AND AFTERAPRIL 15, 1998 90

B. THE TRUTHFUL REVELATION OF THE FRAUD 102

VIII. ERNST & YOUNG'S KNOWLEDGE OF THE FRAUD 105

A. ERNST & YOUNG'S SCIENTER 105

)

B. FAILURE TO NOTE IMPROPER RECOGNITION) OF MEMBERSHIP REVENUE 107

C. SPECIFIC KNOWLEDGE OF THE CNA CONTRACT FRAUD 108

D. KNOWLEDGE OF THE $170 MILLION COMP-U-CARD) DISCREPANCY 109

E. WILLFUL IGNORANCE OF THE COMP-U-CARDQUARTERLY REPORTING PACKAGES 109

) F. KNOWLEDGE OF INFLATION OF INCOME 110

G. KNOWLEDGE OF MISMATCHING OF REVENUE AND EXPENSES . . 110

H. ERNST & YOUNG'S KNOWLEDGE OF IMPROPER MERGERRESERVES 111

L FAILURE TO REPORT INTERNAL CONTROL DEFICIENCIES 112

J. FAILURE TO MAINTAIN PROFESSIONAL SKEPTICISM 113

)K. FAILURE TO MAINTAIN INDEPENDENCE 115

L. ERNST & YOUNG'S COMPLICITY IN THE MISLEADINGAPRIL 15, 1998 PRESS RELEASE 115

) IX. SCIENTER OF CENDANT AND THE INDIVIDUAL DEFENDANTS 119

A. CENDANT DIRECTORS WHO WERE FORMER CUCINSIDERS AND CFO CORIGLIANO 123

B. DISCOVERY BY SILVERMAN AND SCIENTER AS TOTHE APRIL 15, 1998 AND APRIL 27, 1998 STATEMENTS 127

X. INAPPLICABILITY OF SAFE HARBOR PROVISION 131

XI. APPLICABILITY OF PRESUMPTION OF RELIANCE AND FRAUD ON THEMARKET DOCTRINE 132

XII. CLAIMS UNDER THE EXCHANGE ACT 133

iv

SEVENTH CLAIM FOR RELIEFUNDER SECTION 10(b) OF THE EXCHANGE ACTAND RULE 10b-5(Against Cendant and Certain Individual Defendants) 133

EIGHTH CLAIM FOR RELIEFUNDER SECTION 10(b) OF THE EXCHANGE ACT

0 AND RULE 10b-5 (Against Ernst & Young) 138

NINTH CLAIM FOR RELIEFUNDER EXCHANGE ACT SECTION 20(a)(Against Certain Individual Defendants) 142

XIII. CLASS ACTION ALLEGATIONS FOR ALL CLAIMS 143

JURY DEMAND 145

PRAYER 145

Its

Plaintiffs, individually and on behalf of all others similarly situated, through

their undersigned counsel, allege the following upon personal knowledge as to their own acts,

and on information and belief as to all other matters. Plaintiffs' information and belief is based

upon, inter alia, an investigation by their counsel of publicly filed documents by Cendant0

Corporation ("Cendant" or the "Company") with the Securities and Exchange Commission

("SEC"), press releases and news reports issued by or otherwise concerning Cendant, information

concerning open market purchases and sales of Cendant securities, individual filings of Forms 3,

4, and 5 with the SEC that reflect insider holdings, purchases and sales of Cendant securities, and

other publicly available information.

1. This action seeks remedies against Cendant and Cendant Capital I, certain of

Cendant's current and former directors and officers, Ernst &Young, LLP, and certain underwriter

defendants, pursuant to Sections 11, 12(a)(2), and against all individual defendants under Section

15 of the Securities Act of 1933 (the "Securities Act") for all persons who purchased or acquired

PRIDES from the underwriter defendants between February 24, 1998 and April 15, 1998,

inclusive (the "1933 Act Class").

2. Plaintiffs also bring this action to recover damages for violations of Section

10(b) of the Securities and Exchange Act (the "Exchange Act"), and Rule 10-b-5 promulgated

thereunder, against Cendant, certain of its former officers and directors, and Ernst & Young.

LLP, on behalf of purchasers of PRIDES on the open market during the period from April 16,

1998 through July 13, 1998, inclusive (the "Exchange Act Class").

I. JURISDICTION AND VENUE

3. The claims set forth herein arise under Sections 11, 12(a)(2) and 15 of the

Securities Act of 1933, 15 U.S.C. §§ 77k, 771(2), and 77(o), Sections 10(b) and 20(a) of the

Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. §

240.10b-5.

4. The jurisdiction of this court is founded upon Section 22(a) of the Securities

Act, 15 U.S.C. § 77v(a), Section 27 of the Exchange Act, 15 U.S.C. § 78aa, and 28 U.S.C.

§§ 1331, 1337.

5. Venue is proper in this judicial district pursuant to Section 22 of the Securities

Act, 15 U.S.C. § 78v, and Section 27 of the Exchange Act, 15 U.S.C. § 78aa . Many of the acts

and transactions giving rise to the violations of law complained of herein occurred in this district,

including the preparation and dissemination of various false and misleading statements

complained of herein occurred in this district.

6. In connection with the acts, conduct, and other wrongs complained of herein,

the defendants, directly and indirectly, used the means and instrumentalities of interstate

commerce, including the mails, interstate telephone communications, and the facilities of the

national securities exchanges.

0ALLEGATIONS RELATING TO THE SECURITIES ACT CLAIMS

II. INTRODUCTION

7. Plaintiffs bring this class action to recover damages for violations of the federal

securities laws on behalf of purchasers of a derivative-type convertible security known as

Cendant FELINE PRIDES ("PRIDES"). Cendant Corporation ("Cendant" or the "Company")

and its wholly owned subsidiary, Cendant Capital I, issued the PRIDES in an initial public

offering (the "PRIDES Offering" or "Offering") pursuant to materially false and misleading

registration statements on SEC Form 8-Al2B filed on February 23, 1998, Amendment No. 3 to

2

the Registration Statement on Form S-3 filed with the SEC on February 20, 1998 (the

"Registration Statement") and the forms of prospectus and prospectus supplement for the

PRIDES included therein, and the definitive copies of the prospectus and prospectus supplement

on Form 424B5 with the SEC on February 26, 1998 (the "Prospectus"). The Offering closed on

March 2, 1998. Cendant is the successor entity of CUC international Inc. ("CUC"), which

merged with HFS International Incorporated ("HFS") on December 17, 1997. (The Registration

Statement and Prospectus are Exhibits B and C in the accompanying Appendix.)

8. The Offering involved the sale of approximately $1.5 billion PRIDES.

Defendants Merrill Lynch & Co. and Merrill Lynch, Pierce, Fenner & Smith Incorporated and

Chase Securities Inc., were the underwriters. Collectively they received approximately $40

million of underwriting commissions.

9. Among other financial information, the Registration Statement and Prospectus

contained Cendant's audited consolidated statements of income for the three years ended

December 31, 1996 and the Company's unaudited financial results for 1997. Cendant has now

admitted that these financial results overstated income and revenues and understated expenses by

astronomical amounts.

10. More specifically, on April 15, 1998, Cendant disclosed "accounting

irregularities" that would require it to restate its 1997 net income by $1004115 million, and also

restate earlier periods. These accounting irregularities occurred within former CUC units that

had been audited by Ernst & Young, LLP ("E&Y"). This announcement caused the value of

PRIDES to lose approximately one-third of their value or approximately $400 million of market

capitalization in one day.

3

11. E&Y, CUC's accountant, had audited the 1995 and 1996 financial statements

of CUC which were incorporated into the consolidated financial statements of Cendant contained

in the Registration Statement and Prospectus. E&Y explicitly consented to the incorporation by

reference into the Prospectus and Registration Statement within the section entitled "Experts" of

its unqualified audit opinions on the CUC financials.

12. On July 14, 1998, based upon information developed from an independent

investigation commissioned by the audit committee of the Cendant board of directors, Cendant

disclosed that the accounting irregularities were far more pervasive than had been previously

disclosed and resulted in an overstatement of net income for 1997 that was more than double the

amount announced on April 15, 1998, i.e. over $200 million. It further acknowledged that net

income for 1995 and 1996 had been inflated by approximately $250 million (pre-tax) and that it

would be restating its financial reports for the prior three years, from 1995 through 1997. This

disclosure caused additional substantial decline in the value of the PRIDES.

13. On September 29, 1998, the Company filed with the SEC a Form 10-K/A

restating "its previously reported financial results for 1997, 1996 and 1995." The restatement

showed that the revenues and net income for this period that were reported in the Registration

Statement and Prospectus had been inflated by over $2.1 billion and over $430 million,6

respectively. Further illustrating the magnitude of the difference between the financial picture

presented in the offering materials and the actual facts, in 1997 Cendant had a loss of $217.2

million rather than the reported net income of $55.4 million.

14. In October 1998, the Company also restated its results for the first two quarters

of 1998 and the four quarters of 1997.

4

)

15. As discussed in detail in the Forms 8-K filed with the SEC on August 28, 1998

) containing the Report to the audit committee of the board of directors of Cendant Corporation,

prepared by Wilkie Farr & Gallagher ("Wilkie Farr") and Arthur Andersen LLP ("Andersen")

(the "Report"), the restatements were necessitated by numerous accounting irregularities and)

improper accounting practices in 17 of CUC's 22 units, which inflated CUC's operating income

by approximately $500 million during 1995 through 1997, including unsupported topside

1 adjustments to quarterly results, inappropriate utilization of merger reserves, improper irregular

recognition practices and irregularities concerning the membership cancellation reserve. (An

Appendix to the Report was filed in a Form 8-K/A on September 17, 1998.) (Cendant's Form 8-)

K filed on August 28, 1998 containing the Report is Exhibit M in the accompanying Appendix.)

III. THE PARTIES

) PLAINTIFFS

16. The history of the plaintiffs' PRIDES investments is set forth in the attached

schedule, incorporated herein by reference. Asterisks denote plaintiffs who purchased PRIDES

)directly from an Underwriter Defendant during the period February 24, 1998 to April 15, 1998,

inclusive. Each plaintiff has been damaged directly by the wrongdoing complained of. Each

plaintiff has filed a certificate that has been made part of the record of these proceedings, except

for Mr. Fugitt, whose certificate is attached hereto.

5

DEFENDANTS

A. CENDANT DEFENDANTS

17. Defendant Cendant is a Delaware corporation with executive offices in

Parsippany, New Jersey. Cendant is identified in the Registration Statement and Prospectus as

one of the two issuers of the PRIDES Offering. (Registration Statement at S-7; Prospectus at S-

7.)

18. Cendant, which had operated under the corporate name of CUC prior to its

December 17, 1997 merger with HFS, provides all of the services formerly offered by both CUC

and HF S.

19. CUC had been a membership-based consumer services company providing

members with access to a variety of goods and services. It also offered consumer software

through certain businesses acquired during 1996. The membership business offered a variety of

goods and services. CUC categorized the membership services offered as individual, wholesale

and discount programs.

20. CUC's membership activities were conducted through its Comp-U-Card

division and, as of December, 1997, through approximately 20 wholly-owned subsidiaries

located throughout the United States and Europe. The Comp-U-Card division was CUC's largest

business unit and its general ledger functioned as the general ledger for CUC Corporate.

21. CUC used a fiscal January 31 year-end and quarters ending January 31, April

30, July 31 and October 31. Therefore, CUC's "fiscal 1997" refers to the year ended January 31,

1998; "fiscal 1996" refers to the year ended January 31, 1997, and so forth. Following the

merger of CUC and HFS, Cendant reported on a calendar year basis.

6

22. The other issuer of the PRIDES Offering identified in the Registration

Statement and Prospectus is Cendant Capital I. (Registration Statement at S-7; Prospectus at S-

7).

23. Defendant Cendant Capital I is a wholly owned subsidiary of Cendant.

(Prospectus at 24. Cendant's quarterly report on SEC Form 10-Q/A for the quarterly period

ended March 31, 1998, filed on October 13, 1998 p. 19 at 10.) It is a statutory business trust

formed by Cendant under the Delaware Business Trust Act. The February 5, 1998 declaration

creating Cendant Capital I was qualified as an indenture under the Trust Indenture Act of 1939,

as amended. Cendant has declared in its Prospectus that this trust was created for the exclusive

purpose of enabling the creation and issuance of PRIDES by providing the indenture trust

structure necessary for the issuance of trust securities and investing the gross proceeds from the

sale of such trust securities so as to create the form of PRIDES securities described in the

Prospectus and sold in the Offering. (Prospectus at 1, 5).

24. Cendant and Cendant Capital I are together referred to as the "Cendant Defen-

)dants."

B. THE INDIVIDUAL DEFENDANTS

I. Inside Directors of Cendant

a. Former CUC Inside Directors

25. Defendant Walter A. Forbes ("Walter Forbes") was chairman of the board of

directors ("Cendant Board") and a director of Cendant throughout the class periods as defined

below. Forbes signed the Registration Statement through his attorney-in-fact and agent. In 1973,

Forbes founded what subsequently became CUC. Before the Merger, Forbes had served as

7

CUC's chief executive officer, director, chairman of the board of directors ("CUC Board"), and

as a member of the executive committee of the CUC Board. Between the time of the Merger

and the first disclosure of accounting irregularities by Cendant on April 15, 1998, Forbes sold

478,922 shares of Cendant common stock at prices in excess of $38 per share. Forbes realized

gross income of over $17,588,525 from these sales. As shown by SEC filings, Walter Forbes

also sold about $30 million of stock in CUC during the years that accounting irregularities had

inflated profits. The filings show that Walter Forbes regularly sold stock in CUC between 1993

and March 1998, after the Merger but before the drop in stock price. These sales were both on

the open market and through exercising and selling options. Forbes resigned his positions with

Cendant on July 28, 1998.

26. Defendant E. Kirk Shelton ("Shelton") was Cendant's vice chairman, member

of the executive committee of the Cendant Board and director throughout much of the 1933 Act

Class Period as defined below. Shelton signed the Registration Statement through his attorney-

in-fact and agent. Before the Merger, Shelton had served as CUC's president, chief operating

0officer, member of the executive committee of the CUC Board and a director. As CUC's

president and chief operating officer, Shelton reported directly to Walter Forbes. Between the

time of the Merger and the first disclosure of accounting irregularities by Cendant on April 15,

1998, Shelton sold 62,620 shares of Cendant common stock at prices in excess of $31 per share.

From these sales, Shelton realized gross income of over $1,941,220. Shelton purportedly

resigned his position with Cendant effective July 28, 1998 but was terminated for cause on

August 27, 1998.

8

27. Defendant Christopher K. McLeod ("McLeod") was Cendant's vice chairman,

member of the executive committee of the Cendant Board and a director throughout the class

periods. In addition, McLeod was chief executive officer of Cendant Software, a subsidiary of

Cendant. McLeod signed the Registration Statement through his attorney-in-fact and agent.0

Before the Merger, McLeod had served as director of CUC and held a position as an executive

officer in the office of the president reporting directly to Walter Forbes. McLeod resigned his

positions with Cendant on October 12, 1998.

28. Defendant Robert T. Tucker ("Tucker") was Cendant's vice chairman,

secretary, member of the compensation committee of the Cendant Board and a director

throughout the class periods. Tucker signed the Registration Statement and Prospectus through

his attorney-in-fact and agent. Before the Merger, Tucker had served as secretary and a director

of CUC. Tucker resigned his positions with Cendant on October 12, 1998.

b. Former HFS Inside Directors

29. Defendant Henry R. Silverman ("Silverman") was Cendant's president, chief

executive officer, and director throughout the class periods. Silverman signed the Registration

Statement through his attorney-in-fact and agent. Prior to the Merger, Silverman had served as

president, chief executive officer, director, and chairman of the board of directors of HFS.

Following the resignation of Walter Forbes on July 28, 1998, Silverman became chairman of

Cendant's Board and has continued as Cendant's president and chief executive officer.

Silverman was trained as a tax lawyer. On September 24, 1998, following the decimation of the

price of Cendant's common stock, the Company repriced the stock options it had previously

awarded to certain of the Individual Defendants in order to lower the price at which these options

9

could be exercised. Cendant Press Release (Sept. 24, 1998). In this press release, the Company

'6) also announced defendant Silverman's intent to exercise a portion of his in-the-money stock

options and purchase shares of Cendant common stock which would result in his beneficial

ownership of approximately 1.5 million shares. Between the time of the Merger and the first

disclosure of accounting irregularities by Cendant on April 15, 1998, Silverman sold 2,164,210

shares of Cendant common stock at prices in excess of $36 per share. From these sales,

Silverman realized gross income of over $61,420,239.

30. Defendant Michael P. Monaco ("Monaco") was Cendant's vice chairman, chief

financial officer and a director throughout the class periods. Monaco signed the Registration

Statement through his attomey-in-fact and agent. Before the Merger, Monaco had served as vice

chairman, chief financial officer and director of HFS.

31. Defendant Stephen P. Holmes ("Holmes") was Cendant's vice chairman,

member of the executive committee of the Cendant Board and a director throughout the class

periods. Holmes signed the Registration Statement and Prospectus through his attorney-in-fact

and agent. Before the Merger. Holmes had served as vice chairman and a director of HFS.

32. Defendant Robert D. Kunisch ("Kunisch") was Cendant's vice chairman and

director throughout the class periods. In addition, Kunisch was chief executive officer and

president of PHH Corp., a subsidiary of Cendant. Kunisch signed the Registration Statement

through his attorney-in-fact and agent. Prior to the Merger, Kunisch had served as vice chairman

and director of HFS.

33. Defendant James E. Buckman ("Buckman") was Cendant's senior executive

vice president, general counsel and a director throughout the class periods. As described herein,

10

)

Buckman signed the Registration Statement on behalf of himself and as attorney-in-fact and

agent for each of the individual defendants who signed the Statement, and for Cendant. Before

the Merger, Buckman had served as senior executive vice president, general counsel, assistant

secretary and director of HFS. Between the time of the Merger and the first disclosure of)

accounting irregularities by Cendant on April 15, 1998, Buckman sold 300,000 shares of

Cendant common stock at prices in excess of $36 per share. From these sales, Buckman realized

) gross income of over $10, 857,000,

2. Outside Directors of Cendant

a. Former Members of CUC Audit Committee)

34. T. Barnes Donnelly ("Donnelly") was a Cendant director and member of

Cendant's Audit Committee of its Board ("Cendant's Audit Committee") throughout the class

) periods. Before the Merger, Donnelly had been a CUC director and member of CUC's Audit

Committee of its Board ("CUC's Audit Committee") for more than ten years. Donnelly signed

the Registration Statement through his attorney-in-fact and agent. On July 28, 1998 Donnelly

)resigned his positions with Cendant.

35. Stephen A. Greyser ("Greyser") was a Cendant director and member of

Cendant's Audit Committee throughout the class periods. Prior to the Merger, Greyser had been

a CUC director and member of CUC's Audit Committee for more than ten years. Greyser

signed the Registration Statement through his attorney-in-fact and agent. On July 28, 1998

) Greyser resigned his positions with Cendant.

36. Burton C. Perfit ("Perfit") was a Cendant director and member of Cendant's

Audit Committee throughout the class periods. Prior to the Merger. Perfit had been a CUC

11

director and the chairman of CUC's Audit Committee for more than ten years. Perfit signed the

Registration Statement through his attorney-in-fact and agent. Between the time of the Merger

and the first disclosure of accounting irregularities by Cendant on April 15, 1998, Perfit sold

3,938 shares of Cendant common stock at prices in excess of $35 per share. From these sales,

Perfit realized gross income of over $140, 783. On July 28, 1998, Perfit resigned his positions

with Cendant.

b. Certain Other Outside Directors

37. Bartlett Bumap ("Burnap"), Martin L. Edelman ("Edelman") Stanley M.

Rumbough, Jr. ("Rumbough"), and John D. Snodgrass ("Snodgrass") were directors of Cendant

throughout the class periods. Each signed the Registration Statement through his or her attorney-

in-fact and agent.

38. Between the time of the Merger and the first disclosure of accounting

irregularities by Cendant on April 15, 1998, Burnap, Edelman, Rumbough, and Snodgrass sold

shares of Cendant common stock. Bumap sold 575,000 shares of Cendant common stock at

prices in excess of $38 per share. From these sales, Bumap realized gross income of over

$19,997,000. Edelman sold 60,000 shares of Cendant common stock at prices in excess of $40

per share. From these sales, Edelman realized gross income of over $2,447,400. Rumbough sold

75,938 shares of Cendant common stock at prices in excess of $37 per share. From these sales.

Rumbough realized gross income of over $2,756,190. Snodgrass sold 1,604,449 shares of

Cendant common stock at prices in excess of $40 per share. From these sales, Rumbough

realized gross income of over $60, 876, 832. Bumap and Rumbough resigned their positions

with Cendant on July 28, 1998.

12

3. Other Individual Cendant Defendants

0 39. Defendant Scott E. Forbes ("Scott Forbes") was senior vice president-Finance

and Chief Accounting Officer of Cendant throughout the class periods. Scott Forbes signed the

Registration Statement through his attorney-in-fact and agent to sign the Registration Statement

on his behalf. Scott Forbes is not related to Walter Forbes.

40. The individuals named as defendants are referred to as the "Individual Defen-

dants."

41. Each of the Individual Defendants, by reason of their positions, were

controlling persons of Cendant within the meaning of Section 15 of the Securities Act. Because

of their executive, managerial, and/or directorial positions with Cendant, the Individual

Defendants had access to the adverse, non-public information about the financial condition,

operations, and future business prospects of Cendant as particularized herein and improperly

omitted to disclose the same. Any acts attributed herein to Cendant were caused and/or

influenced by the Individual Defendants by virtue of their domination and control thereof.

C. ACCOUNTANT DEFENDANT

42. From 1983 through early 1998, E&Y had been the independent auditor for

CUC. E&Y issued unqualified opinions on CUC's consolidated financial statements for the

fiscal years ended January 31, 1997, 1996 and 1995. E&Y's opinions inaccurately represented

that its audit of CUC's fiscal 1997, 1996, and 1995 annual financial statements were conducted

in accordance with generally accepted auditing standards ("GAAS"), and that CUC's financial

statements fairly presented CUC's financial condition and results of operations in conformity

with GAAP. The Registration Statement and Prospectus within the section entitled "Experts,"

13

incorporated therein by reference, with E&Y's consent, E&Y's unqualified audit report on

CUC's financials for "each of the three years in the period ended January 31, 1997".

43. E&Y also reviewed and reported on CUC's quarterly financial statements,

provided opinions on Cendant' financial statements in connection with acquisitions by CUC,

analyzed CUC's internal controls, and involved itself in the management of CUC in its role as

management consultant.

0

44. E&Y performed numerous management consulting and accounting services for

CUC prior to and during the class period. Among other things:

A. E&Y acted as a business consultant to CUC. In that role, E&Yconducted an extensive review of the status of and prospects for CUC'smerger integrations;

B. E&Y reviewed CUC's quarterly financial statements and providedreports to CUC's Audit Committee concerning the conformity of thesefinancial statements with GAAP;

C. E&Y analyzed CUC's internal controls and reported to CUC's AuditCommittee concerning its analysis; and

45. E&Y's extensive involvement with CUC also included the following:

A. E&Y had unlimited access to all of CUC's books, records anddocuments;

B. several of CUC's employees responsible for accounting and financialmatters had previously worked at E&Y, including defendant Corigliano,Pember, Controller of CUC, CUC's Spark's divisional controller, KevinT. Kearney, and Mary Sattler, current manager of financial reporting ofCendant and former assistant to Pember; and

5 C. E&Y personnel regularly attended meetings of the CUC Board and AuditCommittee.

14

46. Furthermore, E&Y also audited the financial statements of a Cendant

subsidiary, Cendant Membership Services ("CMS"), including for the year ended December 31,

1997, and issued an unqualified report thereon.

47. In connection with the services E&Y provided to CUC, E&Y personnel were

frequently present at CUC's corporate headquarters throughout the year, and had continual access

to and knowledge of CUC's confidential corporate financial, operating and business information.

E&Y personnel responsible for auditing CUC's financial statements included those who attended

meetings of the Audit Committee of CUC's board of directors.

48. CUC was one of the largest clients of E&Y's Stamford Connecticut office.

E&Y was paid at least $750,000 in fees for services rendered in 1997. The compensation of

E&Y partners reflected the financial performance of the office in which they are located. Thus,

fees from CUC engagements had a direct economic impact on the earnings of E&Y partners in

the Stamford office. E&Y also received fees from CUC for services in connection with its

acquisitions, and CUC's ability to make further acquisitions depended on the company's reported

financial performance. E&Y had reason for concern about retaining and/or expanding its

business relationship with CUC, having lost CUC's audit business to Deloitte and Touche

("Deloitte") in connection with the Merger. E&Y placed undue reliance on CUC's

management's representations and was lax in undertaking verifications because it wanted to

retain CUC as a client and maintain its competitive position.

D. UNDERWRITER DEFENDANTS

49. During the class periods, defendant Merrill Lynch & Co. ("Merrill Lynch &

Co."), a Delaware corporation, had its principal place of business at 250 Vesey Street, World

15

Financial Center, N Tower, New York, New York. Merrill Lynch & Co. is a holding company

that through its subsidiaries and affiliates, provides investment, financing, advisory, insurance,

and related services on a global basis. More specifically, these services include investment

banking, underwriting, strategic services, and other corporate finance advisory services to a wide

array of clients, including large corporations such as Cendant. Merrill Lynch & Co. had a history

providing investment banking services to Cendant predecessors, and a financial interest in

continuing the relationship. Throughout the class periods, Merrill Lynch & Co. had a securities

analyst, Mark Miller, follow and report on Cendant with a view to generating brokerage coverage

business for the firm.

50. During the class periods, defendant Merrill Lynch, Pierce, Fenner & Smith

Incorporated ("Merrill Lynch, Pierce") was a Delaware Corporation, doing business throughout

the United States. Merrill Lynch, Pierce is one of the largest securities firms in the world

providing brokerage, investment banking services and insurance products to over nine million

retail and institutional investor accounts. Merrill Lynch, Pierce regularly makes a market in

1equity securities of approximately 550 U.S. corporations. In addition, it engages in market-

making for approximately 4,800 securities of non-U.S. issuers traded in the over-the-counter

1 markets.

51. During the class periods, defendant Chase Securities Inc. ("Chase"), a

Delaware corporation, had its principal place of business at 270 Park Avenue, New York, New

York. Chase offers various investment banking and financial advisory services in connection

with mergers and acquisitions, financial structuring and loan syndications.

16

52. Merrill Lynch & Co. and Merrill Lynch & Pierce (together referred to as

"Merrill") and Chase ("The Underwriter Defendants") were underwriters regarding the PRIDES

that were sold pursuant to the Registration Statement and Prospectus. As such, and by their

material role in respect of road shows, inter alia, they successfully solicited and were substantial

factors in the purchase of the PRIDES, motivated in part to generate greater fees for themselves

and to obtain other economic benefits in connection with the offering and those of the issuer.

Both Merrill and Chase regularly conduct business in this district.

53. Prior to the PRIDES Offering, the Underwriter Defendants were required to

conduct an investigation into the business, operations, business strategy, prospects, financial

condition and accounting and management control systems of Cendant, known as a "due

diligence investigation." In the course of such investigation, the Underwriter Defendants would

have obtained knowledge of the facts alleged herein if they had acted with reasonable care,

including but not limited to making reasonable attempts to verify the data submitted to them.

The Underwriter Defendants had ready access to the subsidiary documents that revealed the

actual results of CUC and were negligent either for not obtaining, or reviewing such materials, or

for blindly relying on the auditors in the presence of red flags, discussed below.

54. Defendant Underwriters, in the absence of negligence on their parts, should

have known the adverse non-public information about Cendant's accounting and financial results

and reporting practices that were materially untrue or misleading in the Registration Statement

and Prospectus. The Underwriter Defendants substantially participated in the commission of the

wrongs alleged under the Securities Act herein through their involvement in the PRIDES

Offering. The Underwriter Defendants were at all times engaged in the business of investment

17

)

banking underwriting and selling securities to the investing public. The Underwriter Defendants

were the lead underwriters of the Offering, for which they received substantial fees in the least of

approximately $43 million in underwriting commissions. After purchasing the shares in the

Offering from the Company, the Underwriter Defendants sold the shares to the investing public.)

E. CERTAIN NON-PARTIES: OTHER CENDANTOFFICERS AND EMPLOYEES

55. Stuart L. Bell ("Bell") was CUC's Chief Financial Officer from 1981 until his)

departure in January, 1995. Bell was a member of the office of the president along with Shelton

and McLeod. Corigliano replaced Bell as CUC's Chief Financial Officer. Bell reported to

) Walter Forbes.

56. Defendant Cosmo Corigliano ("Corigliano") was executive vice president of

Cendant from the commencement of the 1933 Act Class Period through April 9, 1998. Before)

joining CUC in 1983 as assistant controller, Corigliano had been employed by E&Y. Prior to the

Merger, Corigliano had been senior vice president and chief financial officer of CUC and

) reported directly to Shelton. On April 17, 1998, Cendant disclosed that it had terminated

Corigliano for cause from his positions with the Company.

57. Amy N. Lipton ("Lipton") came to CUC in 1987 as its first lawyer. She was

)vice president and CUC's general counsel until the Merger. After the Merger, Lipton became

general counsel of Card Member Services ("CMS"), a subsidiary of Cendant, as well as deputy

general counsel and executive vice president of Cendant. Lipton reported to Bell until his

departure in 1995, and then to Shelton. After the Merger, she reported to Buckman.

18

58. Anthony L. Menchaca ("Menchaca") came to CUC in July 1985 and held a

variety of positions thereafter. In 1995, he became president of the Comp-U-Card division, and

reported to McLeod. When McLeod became CEO of the Software division in early 1997,

Menchaca began reporting to Shelton and continued to do so until April 1998. After the Merger.

Menchaca continued to run Comp-U-Card and in April, 1998 he was named Co-Chairman of

what is now known as Cendant's Alliance Marketing Group, comprising Comp-U-Card and the

other former membership businesses of CUC.

59. John H. Fullmer ("Fullmer") came to CUC in April 1980 and held a variety of

positions over the years in the areas of marketing, sales and product development. He became

executive vice president of the Comp-U-Card division in March, 1991, and chief marketing

officer of CUC in April, 1996, titles he held until the Merger. In April, 1998, he became co-

) chairman of the Alliance Marketing Group, along with Menchaca. He is also the Chief

Marketing Officer of Cendant.

60. Tobia Ippolito ("Ippolito") was Cendant's Vice President and Corporate

Controller throughout the class periods.

61. Anne M. Pember ("Pember") replaced Corigliano as the corporate controller of

the Comp-U-Card division in April, 1995. Pember previously had been employed by E & Y

from 1981 through 1983, and had joined CUC in March, 1989. During her tenure as controller of

Comp-U-Card, Pember reported to Corigliano. In June, 1997 she was promoted to senior vice

president and controller for CUC and continued to report to Corigliano. After the Merger,

Pember did not assume a new title and continued in her role as senior vice president while

management reorganized her CUC responsibilities into a new position.

19

62. Casper Sabatino ("Sabatino") joined CUC as the Manager of Financial

0 Reporting in 1985. He was promoted to director of Financial Reporting in approximately 1988

and then to vice president of Accounting and Financial Reporting in June, 1991. Sabatino

currently is the vice president of Business Development for Cendant. Prior to 1998, Sabatino0

reported principally to Corigliano and Pember. Since March, 1998, Sabatino has reported to Scott

Forbes.

63. Kevin T. Kearney ("Kearney") joined CUC in 1993 as Manager of Financial

Reporting in the corporate office in Stamford, reporting to Sabatino. Prior to coming to CUC,

Kearney worked for E&Y for approximately four years. Kearney was promoted to director of

Financial Reporting around July, 1995, and continued to report to Sabatino. Ile became the

controller of Spark in March, 1997 and remains in this position.

64. Kathleen M. Mills ("Mills") came to CUC as a junior accountant in the Comp-

U-Card division's revenue accounting area in 1991 and remained in that position until July,

1993. Mills was the supervisor of the Financial Reporting Department of CUC from July, 1993

to October, 1995. Mills was promoted to manager of Financial Services or CUC in October,

1995 and remained there until June, 1997.

B

65. Mary Sattler ("Saltier") came to CUC as supervisor of Financial Reporting in

December, 1995 and remained in that position until the Merger. Prior to coming to CUC, Sattler

was employed as a staff accountant at E&Y. Sattler is currently the manager of Financial

Reporting of Cendant. Sattler reported to Kearney who reported to Sabatino prior to Kearney's

move to Spark in 1997. After June, 1997, Sattler reported to Pember.

20

66. Steven P. Speaks ("Speaks") joined SafeCard Services, Inc., a subsidiary of

Ideon based in Cheyenne, Wyoming, as controller for Client Services in July, 1993 and thereafter

held various positions.

67. Bruce B. Tolle ("Tolle") joined CUC as a supervisor of the General Ledger of

the Comp-U-Card division in 1997. Tolle was promoted to the position of manager of the

General Ledger of CMS in March, 1998. Tolle reported to Paul J. Hiznay ("Hizany"),

Accounting Manager, before Hiznay left CUC in October, 1997. After Hiznay left, Tolle

reported to Speaks.

68. The E&Y partner in charge of the audits of CUC's financial for the years ended)

December 31, 1997 and January 31, 1997 was Marc Rabinowitz ("Rabinowitz") and the review

partner was Louis Scherra ("Scherra").

IV. BACKGROUND

A. CUC MERGES WITH HFS AND CHANGESNAME TO CENDANT

)

69. On May 27, 1997, CUC and HFS entered into a merger agreement. The

Merger was approved by the shareholders of both companies on October 1, 1997, and was com-

pleted on December 17, 1997. CUC was the surviving entity and was renamed Cendant Corpora-

)tion.

70. Pursuant to the Plan for Corporate Governance (the "Governance Plan")

executed in connection with the Merger, the Cendant Board was expanded to twenty-eight)

members, fourteen of whom were to be appointed by CUC and fourteen by HFS. The

Governance Plan provided that the compensation and audit committees would each be comprised

)

21

of two directors appointed by CUC and two by HFS. It also established the managerial positions

that the CUC and HFS officers would occupy in the new entity and provided for the succession

of leadership in the year 2000. As part of this Governance Plan, Silverman was to serve as CEO

irnmediately after the Merger—and for his team to run the combined companies—while Walter

Forbes was to serve as chairman of the Cendant Board. The two men would then shift positions

on January I, 2000.

71. Also pursuant to the Governance Plan, most of the former executives of both

HFS and CUC remained with Cendant. Furthermore, CUC's financial and accounting personnel

continued to obtain and consolidate the financial information from the different CUC units.

including Comp-U-Card, its largest subsidiary. (Report at 51.)

72. As a result of the Merger, senior management of both companies received

additional benefits including in most cases increased base salaries, increased bonus

compensation, improved severance benefits, additional stock options, immediate vesting of

certain options, and in the case of CUC management, lapsing of restrictions on restricted stock

and acceleration of lump sum payments under the senior executive retirement plan. (Report at

46.).

B. THE PRIDES OFFERING AND SURROUNDINGCIRCUMSTANCES

73. On January 27. 1998, Cendant made a proposal to acquire American Bankers

Insurance Group Inc. ("American Bankers") for an aggregate purchase price approximating $2.7t$

billion on a fully diluted basis. In connection with the proposal to acquire American Bankers,

Cendant entered into a commitment letter dated January 23, 1998, with The Chase Manhattan

22

)

Bank, and Chase Securities Inc., one of the defendant underwriters here, to provide a $1.5 billion

364-Day revolving credit facility, the same approximate amount that the PRIDES would realize

upon their sale.

74. On January 29, 1998, a few days after Cendant's announced proposal to)

acquire American Bankers, Cendant filed with the SEC a registration statement which eventuated

into the issuance of 26,000,000 PRIDES expected to raise for Cendant at least $1,265,000,000

) and possibly $1.5 billion (considering the underwriters' additional allotments). This registration

statement was amended on three occasions—February 6, 1998, February 17, 1997 and February

20, 1998—before it became effective. The final Prospectus for the PRIDES offering is dated

February 24, 1998 and was filed with the SEC on February 26, 1998. The PRIDES Offering

commenced on February 24, 1998.

)

75. The Registration Statement and Prospectus offered two types of FELINE

PRIDES for sale: Income PRIDES and Growth PRIDES. In general, the Income PRIDES pay a

specified amount to the holders thereof for three years and then, at maturity, are automatically

)converted into Cendant common shares. The Income PRIDES and similar types of securities

have been extremely popular because they offer a high rate of return and a greater potential

equity upside than normal convertible securities. There was such a demand for the Income

PRIDES that the Offering was increased by $300 million above the amount initially planned.

76. Specifically, each of the Income PRIDES consists of a unit comprised of a

Purchase Contract under which the holder will purchase from Cendant on February 16, 2001 for

$50 (the "Stated Amount") in cash, a specified number of newly issued shares of Cendant

common stock, and Cendant will pay to holders "Contract Adjustment Payments" at the rate of

23

5% of the Stated Amount per annum, and an interest in Trust Preferred Securities ("Trust

Preferred Securities") paying 6,45% of the Stated Amount per annum, and paying the holders

$50 at maturity. Holders own the Trust Preferred Securities, but pledge them to the Company to

secure their obligations under the Purchase Contract. Pursuant to the terms of the Registration

Statement, Cendant Capital I acts as the Indenture Trustee for the Trust Preferred Securities

pledged by the purchasers of Income PRIDES.

77. Each of the Growth PRIDES consists of a unit comprised of a Purchase

Contract under which the holder will purchase from the Company on February 16, 2001 for the

Stated Amount in cash, a specified number of newly issued shares of Cendant common stock,

and Cendant will pay to holders "Contract Adjustment Payments" at the rate of 5 €1/0 of the Stated

Amount per annum, and a 1/20th undivided beneficial interest in a treasury security having a

principal amount of $1000 and maturing in 2001.

78. The trading price of the Income and Growth PRIDES in the secondary market

was and is greatly dependent on the financial performance of Cendant. As acknowledged in the

Registration Statement and Prospectus:

The trading prices of Income PRIDES and GrowthPRIDES in the secondary market will be directly affected bythe trading prices of the Common Stock in the secondarymarket, the general level of interest rates and the credit qualityof the Company. It is impossible to predict whether the price ofthe Common Stock or interest rates will rise or fall. Tradingprices of the Common Stock will be influenced by theCompany's operating results and prospects and by economic,financial and other factors and market conditions that can affectthe capital markets generally, including the level of, andfluctuations in, the trading prices of stocks generally and salesof substantial amounts of Common Stock in the marketsubsequent to the offering of the Securities or the perception

24

that such sales could occur. Fluctuations in interest rates maygive rise to opportunities of arbitrage based upon changes in therelative value of the Common Stock underlying the PurchaseContracts and of the other components of the FELINEPRIDES. Any such arbitrage could, in turn, affect the tradingprices of the Income PRIDES, Growth PRIDES, TrustPreferred Securities and Common Stock.

)

(Id at S-29 - S-30.)

79. The Offering was underwritten by Merrill and Chase.

) 80. The Offering closed on March 2, 1998, with Cendant announcing that Merrill

and Chase had exercised their option to purchase an additional allotment of $195 million of

PRIDES. Thus, the Offering succeeded in raising approximately $1.5 billion for Cendant, less)

expenses, or an amount roughly equivalent to the increased debt Cendant intended to assume in

order to complete the American Bankers transaction.

)

81. Of this amount the Underwriter Defendants realized approximately $43 million

in underwriting commissions.

82. On March 5, 1998, Cendant filed with the SEC a Form 8-K concerning the

)March 2, 1998 consummation of the Offering.

V. CLAIMS UNDER SECTIONS 11 AND 12(a)(2) OF THE SECURITIES ACT

A. THE MATERIALLY FALSE AND MISLEADINGREGISTRATION STATEMENT

83. Among other financial statements, report and information, the Registration

Statement and Prospectus contained the following:

A. Cendant's Consolidated Balance Sheets for the years ended December31, 1996 and 1995 (audited) (Registration Statement and Prospectus atF3);

25

B. Cendant's Consolidated Statements of Income for the years endedDecember 31, 1996, and 1995 (audited) (Registration Statement andProspectus at F-5). More specifically, concerning its 1996 results,Cendant reported net income of $423.6 million or diluted earnings pershare of $0.52, and revenues of $3.9 billion; and as to its 1995 results,reported revenues of $3.0 billion or a diluted earnings per share of $0.42,and net income of $302.8 million.

C. Cendant's Consolidated Balance Sheets for September 30, 1997(unaudited) (Registration Statement and Prospectus at p. F-55 - F-56);

D. Cendant's Consolidated Statements of Income for the three monthsended September 30, 1997 (unaudited) (Registration Statement andProspectus at F-57): Cendant reported net income of $248.3 million ordiluted earnings per share of $0.28, and revenues of $1.4 billion; and forthe three months ended September 30, 1996 (id): reported net income of$68.5 million or diluted earnings per share of $0.08, and revenues of $1.0billion; and

E. Cendant's Consolidated Statements of Income for the first nine monthsended September 30, 1997 (unaudited) (Registration Statement andProspectus at F-57): Cendant reported net income of $400.7 million ordiluted earnings per share of $0.47 per share, and revenues of $3.9billion; and for the first nine months ended September 30, 1996 (id.):reported net income of $265.5 million or diluted earnings per share of$0.33, and revenues of $2.8 billion.

84. Furthermore, the Registration Statement and Prospectus also described

Cendant's consolidated financial results for the 1997 year ended December 31, 1997, which

results it had first announced on February 4, 1998 (Registration Statement and Prospectus at S-

P37). More specifically, in the section of this document entitled "Recent Developments," Cendant

stated:

On February 4, 1998, the Company announced its financialresults for the year ended December 31, 1997. The Companyreported diluted earnings per share of $1.00 for 1997, a 49%increase compared to $.67 earnings per share reported for 1996,excluding one-time charges recognized in both 1997 and 1996.The Company had revenues of $5.3 billion for 1997, compared

26

with $3.9 billion for 1996, an increase of 36%, and net incomeof $872.2 million for 1997, excluding one-time charges,compared with $542.3 million of 1996, excluding one-timecharges, an increase of 61%. On a pro forma basis, whichassumes that the financial results include all of the Company's1996 acquisitions, accounted for under the purchase method, asif they had occurred as of January 1, 1996, earnings per sharefor the year ended December 31, 1997, excluding one timecharges, was $1.00 representing a 43% increase over pro forma$.70 per share for the year ended December 31, 1996.

When giving effect to one-time charges, the Companyreported $.06 diluted earnings per share for the year endedDecember 31, 1997 and net income of $55A million for 1997compared to $423.6 million for 1996. In 1997, one-timecharges totaled $1.1 billion ($816.8 million after tax, or $.94per share) for merger related costs and unusual charges . . . . In1996, one-time charges totaled $179.9 million ($118.7 million

6 after-tax, or $.15 per share) related to three CUC mergers.

85. Cendant's consolidated audited results for the year ended December 31, 1997

were filed with the SEC on March 31, 1998 on a Form 10-K, which included E&Y's unqualified

audit opinions on CUC's financial statements for fiscal 1997 and 1996.

86. The financial data and results reported in the Registration Statement and

Prospectus for 1997, 1996 and 1995 (both year-end and quarterly information) detailed above

were materially false and misleading, as Cendant has subsequently admitted on numerous

occasions.

87. Because Deloitte, Cendant's current auditor at the time of the Offering, was not

involved in the fiscal 1995, 1996 or 1997 audits of CUC or HFS, it issued the following

statement in the Registration Statement and Prospectus:

In our opinion, based on our audits and the reports of .. . otherauditors, the consolidated financial statements referred to [para-graphs above] present fairly, in all material respects, thefinancial position of Cendant Corporation and subsidiaries at

27

December 31, 1996 and 1995, and the results of theiroperations and their cash flows for each of the three years in theperiod ended December 31, 1996 in conformity with generallyaccepted accounting principles.

Id at F-2. Deloitte further represented, as per the audits of the "other auditors," that CUC had "total

assets of approximately $2.5 billion and $2.1 billion as of January 31, 1997 and 1996, respectively,

and net income of approximately $164.1 million, $145.0 million and $164.1 million for the years

ended January 31, 1997, 1996 and 1995, respectively."

88. The Registration Statement and Prospectus expressly referred to E&Y's audit

opinions on CUC's financials and incorporated them by reference. In this regard both the

1r Registration Statement and Prospectus, through this attached document, stated under a section

captioned "Experts":

The consolidated financial statements of the Company and itsconsolidated subsidiaries, except PHH Corporation ("PHH"),as of December 31, 1996 and January 31, 1996 and for theyears ended December 31, 1996, January 31, 1996 and 1995and CUC International Inc. ("CUC") as of January 31, 1997and 1996 and for each of the three years in the period endedJanuary 31, 1997 incorporated in this Prospectus by referencefrom the Company Form 8-K dated January 29, 1998, havebeen audited by Deloitte & Touche LLP, as stated in theirreport which is incorporated herein by reference. The financialstatements of PHH (consolidated with those of the Company)have been audited by KPMG Peat Marwick LLP, independentauditors of P1111 Corporation, as stated in their reportincorporated herein by reference. . . . The consolidatedfinancial statements of CUC (consolidated with those of theCompany) have been audited by Ernst & Young LLP, as setforth in their report included in the Current Report on Form8-K, dated January 29, 1998 incorporated herein by reference. . . Such supplemental consolidated financial statements of theCompany and its consolidated subsidiaries are incorporated byreference herein in reliance upon the respective reports of such

28

firms given upon their authority as experts in accounting andauditing. All of the foregoing firms are independent auditors.

Registration Statement, Prospectus at 28 (emphasis added).

89. Furthermore, the Form 8-K filed by Cendant dated January 29, 1998 incorporated

in the Registration Statement and Prospectus (id.; see also Registration Statement at S-38, S-42, and

Prospectus at S-39, S-43), included E&Y's March 10, 1997 audit report ("March 10, 1997 Audit

Report") on CUC's financial condition for "each of the three years in the period ended January 31,

1997." In this letter E&Y further represented:

We conducted our audits in accordance with generally acceptedauditing standards. Those standards require that we plan andperform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. Anaudit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and

fs significant estimates made by management, as well asevaluating the overall financial statement presentation. Webelieve that our audits and the reports of other auditors providea reasonable basis for our opinion.

In our opinion, based upon our audits and the reports of otherauditors, the consolidated financial statements referred to abovepresent fairly, in all material respects, the consolidated financialposition of CUC at January 31, 1997 and 1996, and theconsolidated results of its operations and its cash flows for eachof the three years in the period ended January 31, 1997, inconformity with generally accepted accounting principles.

(January 29, 1998 SEC Form 8-K, Exhibit 99.1 at 2.) (Cendant's January 29, 1998 Form 8-K is

Exhibit A in the accompanying Appendix.)

90. Thus, the March 10, 1997 Audit Report was incorporated by reference into the

Registration Statement and Prospectus. Simultaneously, also incorporated by reference was the

29

unaudited computation of Cendant's per share earnings for the three and six-month period ended

June 30, 1997 and for the three and nine-month period ended September 30, 1997.

91. E&Y consented to the incorporation by reference into the Registration State-

ment and Prospectus of its March 10, 1997 Audit Report. Attached to Cendant's Amendment

No. 2 to Form S-3 Registration Statement, filed by the Company on February 17, 1998 in prepa-

ration for the PRIDES Offering, is E&Y's express consent to be referenced as an "expert," which

states:

We consent to the reference to our firm under the caption"Experts" and to the use of our report dated March 10, 1997,included in the Current Report on Form 8-K, dated January 29,1998, with respect to the consolidated financial statements ofCUC International, Inc. incorporated by reference in Amend-ment No. 1 to Form S-3 Registration Statement (No. 333-45227) and related Prospectus of Cendant Corporation(formerly "CUC International Inc.") for the registration of upto $4,000,000,000 of its debt securities, preferred stock and/orcommon stock.

(Registration Statement at Exhibit 23.2.)

92. The March 10, 1997 Audit Report incorporated into the Registration Statement

and Prospectus, as well as the other incorporated unaudited Cendant's per share earnings for the

three and six-month period ended June 30, 1997 and for the three and nine-month period ended

September 30, 1997, were materially false and misleading.

B. CENDANT'S ADMISSIONS AS TO THE FALSITY OF THEFINANCIAL INFORMATION CONTAINED IN THEREGISTRATION STATEMENT AND PROSPECTUS

93. On April 15, 1998, less than six weeks after the consummation of the PRIDES

Offering, Cendant first admitted that the financial results which were reported in the Registration

30

Statement were materially overstated. At that time it announced that it had discovered

accounting irregularities that caused it to overstate net income for 1997 by approximately $100-

$115 million, and earnings per share by approximately $0.1140.13, before restructuring and

unusual charges. As already detailed, in the Registration Statement and Prospectus. Cendant

reported net income of $872.2 million and earnings per share of $1.00, before restructuring and

unusual charges. The pertinent parts of Cendant's April 15, 1998 press release stated:

[Cendantj today reported that, in the course of trans-ferring responsibility for the Company's accounting functionsfrom former [CUC] personnel to former [HFS] accounting per-sonnel and preparing for the reporting of first quarter 1998results, it has discovered potential accounting irregularities incertain former CUC business units which are part of Cendant'sAlliance Marketing Division (formerly the Membership seg-ment). Accordingly, Cendant said it expects to restate annualand quarterly net income and earnings per share for 1997 andmay restate certain other previous periods related to formerCUC businesses.

Based on presently available information, the effect on1997 results is expected to be a reduction to net income priorto restructuring and unusual charges of approximately $100 to$115 million and earnings per share by about 11 to 13 cents,respectively. . .

Cendant said the potential accounting irregularities arelimited to certain former CUC businesses, which accounted forless than one third of Cendant's net income in 1997.

94. In its April 15, 1998 announcement, Cendant also reported that its Audit

Committee had engaged Willkie Farr as special legal counsel, which had retained Anderson, to

perform an independent investigation of the accounting irregularities.

95. On April 14, 1998, Steven Speaks and Casper Sabatino signed affidavits that

swore to facts that pertained to the Cendant April 15, 1998 press release respecting accounting

irregularities.

31

96. The market responded to the April 15, 1998 announcements by reducing

Cendant's market capitalization by approximately $14 billion. Cendant's stock price plunged

from the April 15 closing price of $35 518 per share to close at $19 1/16 per share, reflecting

more than a 46% drop on April 16, 1998. At the same time, the price of the Income PRIDES fell0

from $49-3/16 to $33-3/4, a more than 31% drop, while the Growth PRIDES dropped from $42-

1/8 to $25-3/4, a more than 38% drop.

97. Prior to this April 15, 1998 announcement, there had been no public disclosure

of any impropriety in Cendant's reported results. When on April 9, 1998, Cendant had

announced the resignation of its vice chairman, defendant Shelton, and two other top officials,ty

Amy Lipton and defendant Corigliano—all former CUC officers—it had stated only that they

were leaving "to pursue other interests." It was only on April 17, 1998 that Cendant

acknowledged that defendant Corigliano had been terminated.

98. In press releases issued on July 14, 1998, Cendant disclosed that its overstate-

ment of net income for 1977 was more than double what it had reported on April 15, 1998 and

that in addition to 1997, it would also have to restate its financial statements for 1996 and 1995

for an aggregate $250 million, pretax, for accounting irregularities alone. It further disclosed that

in connection with the restatements, Deloitte had replaced E&Y as CUC's auditor.

99. More specifically, Cendant announced:

"In addition, Cendant's investigation now confirms thataccounting irregularities existed in CUC's financialstatements in years prior to 1997 and that in addition to 1997,1996 and 1995 results will be restated to correctirregularities.

. . . .

32

7

Cendant now believes its restatement will lower 1997 netincome before merger-related and one-time charges by 22 to28 cents per share. . . . . Between 16 and 19 cents of the 22to 28 cent 1997 impact of restatement will result from thecorrection of accounting irregularities.

100. Cendant then went on to explain "some of the most significant irregularities

now confirmed".

101. Cendant additionally stated in this release that it "expects to provide detailed

information regarding all material CUC irregular accounting practices when it releases its

restated and re-audited financial statements for the 1995-1997 period."

102. In another release issued later on July 14, 1998, "Cendant said that 1996 and

1995 will be impacted by many of the same items that affected 1997. . . In addition,.. . CUC

also overstated its quarterly results by recording fictitious revenues." The company then

acknowledged that "Nile amounts that are expected to be restated from accounting irregularities

are, on a pre-tax basis, approximately $150 million for 1996 and $100 million for 1995."

103. These July 14, 1998 announcements led to further declines in the prices of both

PCendant common stock and PRIDES. Cendant's stock price dropped from the previous day's

close of $18-7/8 per share to close at $15-11/16 per share on July 14 reflecting an approximate

drop of 17%; the Income PRIDES' price dropped from the previous day close of $34-3/32 per

unit to close at $30-1/4 per unit on July 14, reflecting an approximate drop of 11%; and the

Growth PRIDES' price dropped from the previous day's close of $29-3/8 per unit to close at

$25 per unit on July 14, reflecting an approximate drop of 15 %.

104. On July 28, 1998, Walter Forbes and eight additional members of Cendant's

Board, with prior CUC affiliations, resigned, effective iminediately. The Company also

33

disclosed that the one remaining Cendant director with past CUC affiliation would resign before

the end of 1998.

105. On August 13, 1998, Cendant announced that "its investigation of accounting

irregularities and errors in the CUC businesses was complete." Defendant Monaco was quoted in

this release as stating: "[W]e have unflinchingly accepted and reported Ethel results [of this

investigation]."

106. In this August 13, 1998 release, the Company further disclosed:

[Cendant's} final calculation of the impact of accountingirregularities and errors on its 1997, 1996 and 1995 full yearresults. Cendant will lower 1997 results by $0.28 per share or$392 million pretax. The net impact of this restatement plus$0.02 of discontinued operations will lower net income fromcontinuing operations before one-time merger and otherunusual charges to $0.70 per share versus the $1.00 per sharepreviously [included in the Registration Statement andProspectus} reported. A substantial amount of the adjustmenthad the impact of reducing revenues.

. . .

Cendant will lower 1996 results by $0.18 per share. Cendanthas also determined that certain one-time merger charges takenby CUC in 1996 should be reversed and will eliminate $0.02per share of these charges. 1995 results will be lowered by$0.14 per share.

107. On August 28, 1998, Cendant filed with the SEC a Form 8-K containing

certain "Additional Conclusions of the Audit Committee . . . With Respect to Investigation Into

Accounting Irregularities," the Report, an Addendum to the Report, and a related press release

dated August 27, 1998 concerning the presentation of the Report by the Audit Committee to the

Cendant Board, and a brief description of the Report.

f

34

108. On September 29, 1998, the Company issued a Form 10-K/A ("Amended

10-K") amending the Form 10-K for the year ended December 31, 1997 that it had previously

filed with the SEC on March 31 1997. In this document, Cendant restated "its previously

reported financial results for 1997, 1996 and 1995." (Amended 10-K at 4.) More specifically:

The restated net income (loss) totalled $(217.2) million,$330.0 million and $229.8 million in 1997, 1996 and 1995,respectively ($(0.27), $0.41 and $0.31 per diluted share,respectively). The Company originally reported corresponding

4 net income of $55.4 million, $423.6 million and $302.8 millionin 1997, 1996 and 1995, respectively ($0.06, $0.52 and $0.42per diluted share, respectively).

The Company originally reported $872.2 million of 1997net income excluding merger-related costs and other unusualcharges ("Unusual Charges") or $1.00 per diluted share whichincluded $816.2 million or $.94 per diluted share from continu-ing operations. The restated income from continuing

• operations excluding Unusual Charges, extraordinary gain andthe cumulative effect of a change in accounting totaled $571.0million or $.66 per diluted share. The $245.2 million or $.28per diluted share decrease in income from continuingoperations represents additional after tax expense of $15.3million ($.02 per diluted share) due to ... change in accountingand $229.9 million ($.26 per diluted share) of accounting errorsand irregularities.

The Company originally reported $542.3 million and$364.9 million of 1996 and 1995 net income excludingUnusual Charges, respectively ($0.67 and $0.50 per dilutedshare, respectively). The restated income from continuingoperations excluding Unusual Charges totaled $383.3 millionand $269.2 million in 1996 and 1995, respectively ($0.47 and$0.36 per diluted share, respectively). The $159.0 million and$95.7 million decreases in 1996 and 1995, respectively,primarily represent accounting errors and irregularities in bothperiods.

35

(Id.) (Cendant's September 29, 1998 Form 10-K/A is Exhibit N in the accompanying

Appendix.)

109. Furthermore, in this Amended 10-K, Cendant restated its previously reported

revenues for the 1995 through 1997 years—its actual revenues for 1997 were $4.2 billion rather

than the previously reported $5.3 billion, for 1996 it was $3.2 billion rather than the previously

reported $3.9 billion, and for 1995 it was $2.6 billion rather than the previously reported $2.9

billion. (Id. at F6, F18-F24.)

110. In this Amended 10-K, Cendant admitted that the restatements resulted mostly

from the accounting irregularities and errors revealed by the Company's own investigation and

the Audit Committee's investigation. (Id. at 3-4.)

111. Below is a chart of the some of the material differences between the financial

statements as reported in the Registration Statement and Prospectus and the Amended 10-K:

As PreviouslyReported As Restated

Periods Reported In The Registration Statement and Prospectus

For the Year Ended December 31, 1997:Revenue $ 5,314.7 $4,240 .0Merger related costs & other unusual charges 1,147.9 704.1Cumulative effect of accounting change -0- (283.1)Net income (loss), 55.4 (217.2)Net income (loss) per common share (diluted) 0.06 (0.27)

For the Year Ended December 31, 1996:Revenue $ 3,908.8 $ 3,237.7Merger related costs & other unusual charges 179.9 109.4Income from continuing operations 713.7 533.5Cumulative effect of accounting changes -0- -0-Net income (loss) 423.6 330.0Net income (loss) per common share (diluted) 0.52 0.41

36

For the Year Ended December 31, 1995:Revenue $ 2,992.1 $ 2,616.1Merger related costs & other unusual charges 97.0 97.0Income from continuing operations 503.3 350.3Cumulative effect of accounting change -0- -0-Net income (loss) 302.8 229.8Net income (loss) per common share(diluted) 0.41 0.31

As of December 31, 1996:Total assets $13,588.4 $12,762.5Total liabilities 9,265.7 8,806.8Total stockholders' equity 4,322.7 3,955.7

112. In other words, the consolidated financial statements and results for 1995

through 1997 contained in the Registration Statement and Prospectus overstated the Company's

net income by 439.2 million, its operating income before taxes by $500 million and its revenues

by $2.1 billion.

113. In its Form 8-K filed with the SEC on October 21, 1998, Cendant provided

financial schedules summarizing restated revenue and EBITDA by business segment for all four

quarters of 1997 and the first two quarter of 1998. This document demonstrates the following

overstatements contained in the Registration Statement and Prospectus (at F-57) concerning the

Company's consolidated results for the three months ended September 30, 1997: overstatement

of revenues by $102.9 million and EBITDA by $75.7 million.

114. Thus, Cendant has acknowledged that all the financial data presented in the

Registration Statements and Prospectus concerning the 1995 through 1997 period, whether

quarterly or yearly information, were materially misstated.

37

C. THE NATURE OF THE ACCOUNTING IRREGULARITIES INCENDANT'S FINANCIAL STATEMENTS

115. The Audit Committee Report details the numerous accounting manipulations

that were used to overstate Cendant's consolidated financial results for the 1995 through 1997

years ("Restatement Period"), and also its quarterly results for this period.

116. The Report by Willi& and Andersen was submitted to the Audit Committee,

which preliminarily approved the Report on August 24, 1998 and thereafter finally approved it

before its filing with the SEC on August 28, 1998. (Addendum to Report of the Audit

Committee of the Board of Directors of Cendant Corporation, Exhibit 99.3 to Cendant's report on

SEC Form 8-K filed on August 28, 1998.). The Report was presented to Cendant's full board of

directors on Aug. 27, 1998. (Press Release Aug. 27, 1998)

117. The Report details numerous accounting irregularities and improper accounting

practices that occurred at CUC, which resulted in the already detailed overstatement of Cendant's

consolidated results and CUC's own reported results for the 1995 through 1997 period. The

irregularities can be categorized into five broad categories. (Report at 9.)

1. Topside Adjustments to Quarterly Results

118. At each of the first three fiscal quarters since 1995, CUC inflated its operating

income by increasing revenues and/or decreasing expenses of its largest business unit, the

Comp-U-Card division in Trumbull, Connecticut, without any valid basis. So-called "topside"

entries were made by accounting personnel at corporate headquarters to increase accounts

receivable and revenues, or to decrease accounts payable and expenses, although (as these

personnel acknowledged) there was no actual receivable supporting the entry giving rise to the

revenues, and no actual reduction of a payable obligation to justify the reduced expense. The

38

>

topside entries were not recorded on any general ledger, thereby creating a discrepancy between

the adjusted figures and those reflected on CUC's actual books and records. The amount of these

quarterly adjustments increased during the Restatement Period, from $31 million pretax income

in 1995 to $87 million in 1996 to $176 million in 1997. (Report at 9-10, 68-70, 71-99.)

119. The amount of the income adjustments at each quarter closely mirrored the

amount needed to bring CUC's results into line with Wall Street earnings expectations, e.g., if

actual income in a particular quarter was 10(cents) per share and consensus analysts'

expectations were 18(cents) per share, then adjustments of approximately 8(cents) were made,

without support, to increase earnings. (Report at 10-11, 69, 75-76, 82-87.)

120. The inflated earnings results were then publicly reported and presented to the

CUC Board at each quarter. Because these results were often above the combined budgets of

CUC's individual business units for the quarters, the consolidated quarterly budget figures

presented to the CUC's Board that accompanied the financial results were frequently increased at

corporate headquarters to eliminate any substantial variance. (Id.)

121. In addition to adjusting CUC's income at each quarter to meet Wall Street

expectations, CUC also made quarterly unsupported topside adjustments to its balance sheet,

particularly to show a greater cash balance than CUC actually had on its books. These adjust-)

ments were generally made in conjunction with the earnings adjustments described above.

(Report at 71-99.)

2. Irregularities Involving Utilization of Merger Reserves

122. As a result of the quarterly topside adjustments to earnings, there was a

substantial gap between what was reported to the public and what was recorded on CUC's books.

39

'71

To help close this gap, CUC made various year-end adjustments to its books to increase revenues

or decrease expenses. In 1997, these largely took the form of reversals of previously established

merger and restructuring reserves into income, by decreasing the reserves and correspondingly

increasing income (again either by increasing revenues or decreasing expenses) through

numerous unsupported journal entries. Unsupported journal entries to reduce reserves and

increase income were made after year-end and backdated to prior months; merger reserves were

transferred via intercompany accounts from corporate headquarters to various subsidiaries and

then reversed into income; and reserves were transferred from one subsidiary to another before

being taken into income. Approximately $115 million of merger reserves were improperly

reversed into income at year-end 1997 in these and other fashions. CUC also improperly utilized

merger reserves by writing off assets as impaired against reserves when the assets were not in

fact impaired or where such impairment was unrelated and not coincident to any merger below.

The improper usage of merger reserves occurred in 1995 and 1996 as well, although on a lesser

scale than in 1997. In addition, there is evidence that CUC intended to utilize a portion of the

reserve established in connection with CUC's merger with HFS on December 17, 1997 to

inappropriately increase earnings in 1998 and perhaps in future periods as well. (Report at 11-

12, 100-42.)

3. Irregularities in Connection with Revenue Recognition

123. CUC also improperly recorded revenues on an accelerated basis in relation to

its recognition of the expenses associated with those revenues. Although CUC's stated policy

was to match revenues and expenses, a proper matching was not achieved. A large element of the

mismatching was attributable to CUC's having arbitrarily re-labeled revenues from certain

40

products of its Comp-U-Card division where revenues and expenses were roughly matched over

the membership period, to other products where revenues were recognized immediately while

related expenses continued to be deferred. The impact of CUC's improper revenue recognition

practices was to overstate earnings by approximately $27 million pretax in 1995, $23 million in

1996 and $41 million in 1997. (Report at 12, 199-213.)

4. Irregularities Concerning the Membership Cancellation

Reserve

124. Comp-U-Card's membership cancellation reserve—the provision for potential

membership cancellations and credit card rejections—was substantially understated as of the

0beginning of 1995. Despite this, from time to time during the 1995-1997 time period that

cancellation reserve was improperly reduced, and income increased, through unsupported and

backdated journal entries. (Report at 13-14, 214-38.)

125. To obscure the understatement of the cancellation reserve, and the improper

reversals of that reserve into income, CUC engaged in various other irregular accounting

practices during the 1995-1997 time period. These included the delayed recording of credit card

rejects and the creation of fictitious accounts receivable. (Report at 13-14.)

126. As a result, CUC's reported income for 1995 was inflated by $48 million, for0

1996 was inflated by $19 million, and for 1997 was inflated by $12 million (all pretax). (Report

at 13, 233-38.)

D. VIOLATIONS OF GAAP

127. GAAP are those principles recognized by the accounting profession as the

conventions, rules and procedures necessary to define accepted accounting practice at a particular

41

time. Moreover, SEC Regulation S-X requires that financial statements filed with the SEC

conform with GAAP, and those financial statements which are not prepared in conformity with

GAAP are presumed to be misleading or inaccurate.

128. Cendant's 1996 and 1995 consolidated audited annual financial statements

contained in the Registration Statement and Prospectus did not comply with GAAP. In addition.

Cendant's consolidated quarterly and other interim financial statements that were contained in

the Registration Statement and Prospectus were also materially false and misleading in that they

were not presented in accordance with GAAP. The Accounting Practices Board has stated that

"[t]he accounting principles and reporting practices in the Opinions and Bulletins should apply to

interim financial information in the manner set forth in this opinion." ABP No. 28, 7. As set

forth in ABP No. 28:

Each interim period shall be viewed primarily as an integralpart of an annual period. [APB No. 28, 9] The results for eachinterim period shall be based on the accounting principles andpractices used by an enterprise in the preparation of its latestannual financial statements unless a change in accountingpractice or policy has been adopted in the current year . . .Revenue from products sold or services rendered shall berecognized as earned during an interim period on the samebasis as followed for the full year. [APB No. 28, 1 1] . . . (a)Costs associated with revenue - those costs that are associateddirectly with or allocated to the products sold or to the servicesrendered [are to be] charged against income in those interimperiods in which the revenue is recognized. (b) All other costsand expenses [are] those costs and expenses that are notallocated to the products sold or to the services rendered andare charges against income in interim fiscal periods as incurred,or are allocated among interim periods based on an estimate oftime expired, benefit received, or other activity associated withthe periods. [APB No. 28, If 121

42

129. More specifically, Cendant's financial statements set forth in the Registration

Statement and Prospectus substantially departed from GAAP in at least the following respects:

A. the requirement that revenue cannot be recognized when substantial

contingencies exist as to full and final payment or potential cancellation. (Financial Accounting

Standards Board ("FASB"), Financial Accounting Standards ("FAS") No. 48 (Revenue

Recognition When Right of [Cancellation] Exists);

B. the requirement that any existing condition, situation or set of

circumstances involving an uncertainty when there is at least a reasonable possibility that a loss

or an additional loss may have been incurred must be disclosed. (FASB, FAS No. 5 (Accounting

for Contingencies));

C. the principle that financial reporting should provide information about

the economic resources of an enterprise, the claims to those resources, and the effects of trans-)

actions, events and circumstances that change resources and claims to those resources. (FASB

Statement of Financial Accounting Concepts ("SFAC") No. 1

D. the principle the financial reporting should provide accurate information

about an enterprise's financial performance during a period. (SFAC No. 1, ir 42);

E. the principle that financial reporting should be reliable in that it

represents what it purports to represent. (SFAC No. 2, TT 58-59);

F. the principle of completeness. (SFAC No. 2, TT 79-80); and

G. the principle of conservatism. (SFAC No. 2, TT 95, 97).

43

130. In the Registration Statement and Prospectus, Cendant substantially departed

from basic accounting principles of revenue and expense recognition and matching of revenue

with expenses as more fully described herein.

131. More specifically, Cendant substantially departed from SFAC Nos. 05 and 06.

SFAC No. 6, 78 states:

Revenues are inflows or other enhancements of assets of anentity or settlements of its liabilities (or a combination of both)from delivering or producing goods, rendering services, orother activities that constitute the entity's major or centraloperations.

132. Significantly, 79 explains further that:

Revenues represent actual or expected cash inflows (or theequivalent) that have occurred or will eventuate as a result ofthe entity's ongoing major or central operations.

(Emphasis added.)

133. Here, Cendant recognized revenues that were either fictitious, or were

accelerated, i. e., recorded before the GAAP principles permit for such recognition and in

0 violation of its own stated policy of revenue recognition.

134. With respect to expenses, SFAC No. 06, 41180 states that:

Expenses are outflows or other using up of assets or incurrenceof liabilities (or a combination of both) from delivering or pro-ducing goods, rendering services, or carrying out other activi-ties that constitute the entity's ongoing major or central opera-tions.

135. Further, SFAC No. 06, 1If 81 states that:

Expenses represent actual or expected cash outflows (or theequivalent) that have occurred or will eventuate as a result ofthe entity's ongoing major or central operations.

44

(Emphasis added.)

136. As particularized herein, Cendant recognized revenues and reduced expenses

in violation of these principles. "Recognition is the process of formerly recording or

incorporating an item in the financial statements of an entity as an asset, liability, revenue,

expense or the like. (SFAC No. 05, 1 58)."137. An item cannot be recognized in the financial statements under GAAP unless it

meets four fundamental recognition criteria. Those criteria are:

A. definition: A resource must meet the definition of an asset; an obligationmust meet the definition of a liability; and a change in equity must meetthe definition of a revenue, expense, gain, loss . . .;

0B. measurability: The item must have a relevant attribute that can be

quantified in monetary units with sufficient reliability, the two primaryqualitative characteristics of accounting information;

C. relevance: An item is relevant if the information about it has the capacityto make a difference in investors, creditors' or other users' decisions; and

D. reliability: An item is reliable, if the information about it is representa-tional, faithful, verifiable, and neutral. The information must be faithfulin its representation, free of error, and unbiased.

(SFAC No. 05, 63-77)

138. Revenues and gains are not recognized until realized or realizable, as discussed

0 above. (SFAC No. 05, 1 83(a)). Further, "[r]evenues are not recognized until earned . . . [A]nd

revenues are considered to have been earned when the entity has substantially accomplished what

it must do to be entitled to the benefits represented by the revenues." (Id. at IR 83(b).)

139. An expense or loss is recognized:

[i]f it becomes evident that previously recognized futureeconomic benefits of an asset have been reduced or eliminated,

45

or that a liability has been incurred or increased, without asso-ciated economic benefits.

(SFAC No. 05, If 87.)

140. Further, "once an asset or a liability is recognized, it continues to be measured

at the amount initially recognized until an event that changes the asset or liability or its amount

occurs and meets the recognition criteria." (SFAC No. 05, 1 88.)

141. Here, as particularized by the numerous irregularities listed above, Cendant

substantially departed from the above GAAP principles by recording assets, recognizing

revenues, and reducing valid liabilities and expenses without any basis.

142. In addition, Cendant substantially departed from the GAAP principle of

matching related expenses with revenues. (SFAC No. 06, TT 145-151, SFAC No. 05, 85-86.)

The "matching of costs and revenues is simultaneous or combined recognition of the revenues

and expenses that result directly and jointly from the same transactions or other events." (SFAC

No. 06, 146.)

143. As more fully explained by SFAC No. 6:

In most entities, some transactions or events result simulta-neously in both a revenue and one or more expenses. Therevenue and expense(s) are directly related to each other andrequire recognition at the same time.

)

As explained herein, Cendant substantially departed from this principle by deferring costs related

to membership fee revenues that were recognized.

) 1. Internal Control Deficiencies Cited in Audit Committee Report

144. As defined under SAS No. 60, Cendant had material internal control

weaknesses. Such control weaknesses are required to be reported to the Company's audit

46

committee under auditing standards promulgated by the AICPA under Statement on Auditing

Standard ("SAS") No. 78, "Consideration of Internal Control in a Financial Statement Audit,"

which states, inter alia, that "Material Control Weaknesses" are those weaknesses that:

represent significant deficiencies in the design or operation of

itt the internal control structure, which could adversely affect theorganization's ability to record, process, summarize, and reportfinancial data consistent with the assertions of management inthe financial statements.

145. In the Report and in the Additional Conclusions, the Audit Committee has

recognized basic internal control weaknesses at Cendant. (Report at 73 11.74; Additional

Conclusions, August 28, 1998 Form 8-K at 4.)

2. The Financial Reporting Process

146. The financial reporting process is particularly critical to any organization as its

function is to accumulate a variety of data from various sources in order to produce financial and

other reports for management as well as the shareholders of the company. This process at CUC

contained the following deficiencies:

1

147. The financial reporting process was substantially a manual process. The CUC

manual process (1) did not contain any of the system based checks and balances that exist in

available software, and (2) required multiple handling of data:

A. CUC did not maintain a formal, written accounting policies andprocedures manual governing its financial reporting process;

B. standardized reporting formats, or packages, were not used by the various) divisions of CUC in reporting their financial and other operating data to

CUC Headquarters. Such deficiency meant that the accumulation ofmeaningful financial data on a timely basis was more difficult;

C. a significant number of consolidating entries were not appropriatelydocumented, reviewed or approved;

47

D. an adequate reconciliation process was not in place at CUC, particularlyover critical accounts. Recognizing that CUC could be described as a"cash business," timely and complete reconciliations of cash accounts tobank statements is a critical control feature. While the cash accountswere reconciled to bank statements, such reconciliations containedreconciling items that were not recognized in the accounts on a timelybasis. Specifically, credit card rejects from members, which should havebeen recorded as a reduction in cash and the utilization of thecancellation reserves, were not so recorded during the last three monthsof each fiscal year. A similar reconciliation deficiency existed withrespect to intercompany accounts; and

E. the various data and information systems employed by CUC were notwell integrated. Of particular significance was the process by whichrevenue from membership fees was recorded and recognized. Basicmembership data is maintained by CUC in a computer database.However, certain information is retrieved from that database, andmanually processed each month to produce the amount of revenue to be

0recorded or deferred for financial reporting purposes.

Appendix to the Report of the Audit Committee of the Board of Directors of Cendant

Corporation (dated Aug. 24, 1998), Exhibit 99.6 to Cendant's report on SEC Form 8-K/A filed on

September 17, 1998, Exhibit 128 at 2-3 as on file with the Securities and Exchange Commission.

3. The Budget and Planning Process

148. The budgeting process can be an important management tool to monitor and

control operations and financial reporting. During the 1995-1997 time period, the budgeting

process applied by CUC contained the following deficiencies:

A. consolidated budget for CUC was not prepared for either of the mostrecent two fiscal years. While each of the individual units prepared anannual budget, normally during the November to January time frame,such budgets were not consolidated for these years. In addition, suchbudgets were not prepared on a uniform basis such that a consolidatedbudget could be prepared on a uniform basis such that a consolidatedbudget could be prepared without an extensive amount of additionaleffort; and

48

B. CUC did not engage in a practice of routinely comparing actual results tobudgeted results. Such an exercise of comparing actual results tobudgeted results would identify situations where business conditions mayhave changed, strategies or plans may not have been effectivelyimplemented or other conditions may be developing requiringmanagement attention.

(Id at 3-4.)

4. The Internal Audit Function

149. The Internal Audit function can be an effective control process for

1 management. The Internal Audit function at CUC was deficient in the following ways:

A. Internal Audit did not examine or review financial data. Financialstatements and/or reporting packages from the units, as well asconsolidated financial data, were not reviewed by the Internal Auditdepartment. Rather, the Internal Audit department focused onoperational audits and had, as an objective, the development ofrecommendations to streamline the operational process; and

13. the effectiveness of the Internal Audit function was further reduced inthat there was no evidence to indicate that an audit plan to addresssignificant financial risks to the company would be covered by theInternal Audit function.

(Id at 4.)

5. Information for Management

150. The flow of financial and accounting information to senior management at

CUC contained deficiencies. The following summarizes some of these certain deficiencies:

(a) quality financial information was not available to seniormanagement on a consistent or timely basis. As a matter ofpractice, consolidated financial statements were not prepared on amonthly basis. On a quarterly basis, the accounts were notprepared with the same degree of diligence and attention to detailas was the case with respect to year end financial statements.Specifically, efforts were not made to assure that all necessaryadjustments were made so as to correctly and fairly present thefinancial position and results of operations of the companies as ofeach quarter; and

49

(b) based on discussions with senior management, more emphasis wasplaced on data received directly form the operating units, and lesserimportance was attributed to consolidated financial data,

(Id at 3-4.)

E. THE INDIVIDUAL DEFENDANTS FAILED TO EXERCISEREASONABLE CARE IN THE PREPARATION ANDDISSEMINATION OF THE REGISTRATION STATEMENTAND PROSPECTUS

151. The Individual Defendants should have known that the Registration Statement

and Prospectus was materially false and misleading, but they failed to exercise reasonable care in

the completion of their duties. Because the Individual Defendants either participated directly in

the preparation of the false and misleading financial statements, or they were negligent in

ignoring red flags that should have prompted them to inquire further prior to the Offering, they

cannot assert valid affirmative defenses of due diligence under Sections 11 or 12(a)(2) of the

)Securities Act.

152. As previously detailed, more than one-third of CUC's total reported operating

income during the period of 1995 through 1997 was "improperly inflated," "touch[ing] the large

majority of the company." (Report at 9.) Indeed, the accounting irregularities were "pervasive."

Id The topside adjustments, in particular, which totalled nearly $200 million and were only

) made to the Comp-U-Card division, could easily have been detected by any of the Individual

Defendants had they undertaken their due diligence responsibilities in a serious manner. The

actual unadjusted results for this subsidiary were reflected in very basic and accessible

documents such as Comp-U-Card's quarterly budgets, its general ledger, and other periodic

reports—documents readily available to each of the Individual Defendants.

50

153. The Individual Defendants also knew or should have known that E&Y had a

particularly close relationship with the financial management at CUC that may have

compromised its independence. As detailed herein, many of CUC's management personnel who

played key roles in the falsification of the financial statements—including defendants Corigliano

and Pember, as well as senior officers Kearney and Sattler—were former E&Y employees, and

E&Y realized significant fees from its relationship with CUC. As such, the Individual

Defendants were not justified in blindly relying on E&Y's audits without completing their own

due diligence to confirm the validity of the financial statements.

154. Because the Registration Statement and Prospectus contained unaudited

0financial statements for 1997, the Individual Defendants also could not rely on any auditors with

respect to this data, but had to conduct their own due diligence to assure themselves that the

financial statements were correct, which they failed to do.

155. Moreover, questions should have been raised in the minds of the Individual

Defendants due to the fact that CUC met analysts' expectations with a high degree of precision

for virtually every quarter from 1995 through the Merger. Such precision warranted further

inquiry.

156. Finally, the Individual Defendants should have been on notice of the need to be

particularly careful about potential accounting irregularities at CUC as a result of its history. In

1989, CUC was criticized by investors for spreading out the cost of recruiting new members over

three years instead of reflecting those costs right away. As a result, CUC had to restate its

earnings that year, and took a $51.4 million charge to better reflect membership-acquisition costs

when it changed to a one-year schedule for amortizing recruitment costs. At the time, Walter

51

Forbes said that "it became clear that the market wanted the more conservative policy." Then, in

1991, the SEC questioned the completeness of CUC's financial documents and required

numerous amendments to them. In light of this history, the need for careful due diligence prior

to the Offering was heightened.

I. Cendant Directors Who Were Former CUC Insiders

157. The Cendant directors who had previously served as inside directors or officers

of CUC -- defendants Walter Forbes, Shelton, McLeod and Tucker -- similarly failed to exercise

reasonable care prior to approving the dissemination of the Registration Statement and

Prospectus, which contained materially false and misleading information.

158. CUC maintained two corporate offices on Summer Street in Stamford,

Connecticut. In 1997, the offices of the executive officers responsible for finance and investor

relations were located together on the third floor at 707 Summer Street. Walter Forbes and the

two inside directors that reported directly to him, Shelton and McLeod, were located on the third

floor. Also on the third floor was Corigliano, a key participant in the preparation of the false

financial statements, who reported directly to Shelton, as well as Lipton, Fullmer, and Menchaca.

Thus, the CUC inside directors worked closely with those who admittedly created fictitious

financial results

159. Moreover, these defendants had specific access to documents and information

that should have revealed the accounting irregularities to them. They each received or had access

to sensitive financial information between 1995 and the close of the Offering that provided them

the information necessary to alert them to the accounting irregularities that have now been

disclosed.

52

160. Monthly and quarterly packages were prepared by each subsidiary of CUC,

including Comp-U-Card, which contained the actual, unmanipulated results of each subsidiary.

Had any CUC director examined these basic documents, they would have known that the

consolidated results presented to the Board contained materially inflated results. (Report at 29.)

161. In fact, reporting packages which contained monthly accurate data on Comp-U-

Card and other subsidiaries were distributed to various senior executives, including defendants

Walter Forbes, Shelton and McLeod (as well as Pember and Corigliano, among others). Report

at 33 n.28; 98 n.107. As the Report concluded, these reporting packages "might have alerted [the

recipient] to the fact that the reported quarterly results substantially exceeded the actual results of

the business units." (Report at 98 n.107.)

162. Similarly, the subsidiaries submitted annual budgets to various senior CUC

executives during December or early January of each year. The Comp-U-Card division budget

was widely distributed within CUC, including to Corigliano, Pember, Fullmer, McLeod,

Menchaca and Shelton, among others. Report at 28. As these reports were unaltered, had the

0 Individual Defendants reviewed them and compared them to subsequently altered budgets, the

discrepancies would have been easily identified.

163. In addition to other red flags mentioned herein, Walter Forbes and Shelton

were both on notice of certain accounting irregularities prior to the Offering because of their

personal participation. For example, Shelton authorized more than $500,000 of airplane

expenses incurred by Walter Forbes in 1995 and 1996 to be charged to the reserve established in

connection with the CUC/HFS merger in 1997, even though there was no connection between the

expenses and the merger. (Report at 15-16.) Even assuming the trips were valid business

53

expenses, they should have been charged as an administrative expense. Improperly charging it to

the merger reserve had the effect of decreasing expenses, thus inflating net income, and, when

the reserve was reversed, of inflating revenue.

164. Shelton was also on notice of certain accounting irregularities before the

Offering because of his personal involvement. Among the most compelling examples is a March

6, 1998 meeting between Scott Forbes, an associate of Cendant's president and CEO, defendant

Silverman, and Shelton, Corigliano and other CUC officials, which took place only four days

after the completion of the Offering. At that time, Scott Forbes was told by Shelton that "CUC

wanted [him] to help them be creative in moving $165 million of Cendant merger reserves into

income in 1998," with Shelton suggesting that "it was a good idea to move the reserves around to

various units so that they were not sitting on one division's books." (Report at 57.) Such a shift

in merger reserves violated GAAP, as further set forth below, and was part of the pattern and

practice of accounting irregularities ultimately disclosed by Cendant on April 15, 1998 and

thereafter.

165. In addition, Cendant's Audit Committee specifically held defendants Walter

Forbes and Shelton accountable for the misstatements in CUC's financial reports, stating:

The Report prepared for the Committee by Wilkie Farr &Gallagher and Arthur Andersen LLP has reviewed much of theevidence obtained with respect to whether or not members ofsenior management of the former CUC International, Inc.("CUC") including Walter Forbes, Chairman of the Board andChief Executive Officer, and Kirk Shelton, President and ChiefOperating Officer, had or may have had knowledge of theirregularities detailed in the Report.

It is the view of the Committee that certain additionalconclusions based on the work of the Committee and itsprofessionals should be reported to the full Board. First,

54

Walter Forbes and Kirk Shelton, because of their positions, hadresponsibility to create an environment in which it was clear toall employees at all levels that inaccurate financial reportingwould not be tolerated. The fact that there is evidence thatmany of the senior accounting and financial personnelparticipated in irregular activities and that personnel at many ofthe business units acquiesced in practices which they believedwere questionable suggests that an appropriate environment toensure accurate financial reporting did not exist. Second,senior management failed to have in place appropriate controlsand procedures that might have enabled them to detect theirregularities in the absence of actual knowledge of thoseirregularities. Third, Walter Forbes and Kirk Shelton, theCompany's most senior managers, had a responsibility to fullyunderstand the sources and the true level of CLIC'sprofitability. To the extent that they were unaware of theirregularities, the amount by which CUC's earnings wereinflated as reported in the Restatement suggests that they didnot adequately inform themselves as to the sources and level ofprofitability of the Company. For these reasons at least, WalterForbes and Kirk Shelton are among those who must bearresponsibility for what occurred at CUC.

)(Additional Conclusions.) In effect, the Cendant Audit Committee has expressly concluded that

Walter Forbes and Shelton were negligent in their failure "to fully understand the sources and the

true level of CUC's profitability," and, as such, are responsible for the financial misstatements.)

2. Cendant Directors Who Were Members of the CUCAudit Committee

166. CUC's Audit Committee was designed to play a key role in the management of1

the company. Among other things, this Committee's function was to recommend annually to

CLJC's Board the appointment of the independent certified public accountant, discuss and review

) the scope and fees of the prospective annual audit and any non-audit services of the accountants

and to review the results of any work with the accountants, review compliance with existing

major accounting and fmancial policies of CUC, review the adequacy of CUC's financial)

55

r

organization, and review management's procedures and policies relative to the adequacy of

CUC's internal accounting controls and compliance with federal and state laws relating to

accounting practices.

167. For over ten years prior to the Merger, the CUC Committee had consisted of

the same three individuals—defendants Perfit, Donnelly and Greyser. For this entire period.

Perfit was chairman of this committee. (Report at 27.) During the tenure of Perfit, Donnelly and

Greyser there have been several occasions on which the financial statements of CUC were

misstated due to accounting irregularities, as more fully set forth above. Because Perfit,

Donnelly and Greyser were on notice of CUC's accounting history it was particularly egregious

1 for them to have ignored the red flags of accounting irregularities to which they were exposed

prior to the Offering.

168. Furthermore, Perfit, Donnelly and Greyser's own conduct was a factor in their)

failure to detect the accounting irregularities. Specifically, the CUC Audit Committee met only

three times a year, kept scant minutes, did not play an active role in the auditing of CUC, and did

not provide an adequate check on the compromising relationship between E&Y and CUC's

financial management. By taking such a cavalier approach to their important duties as members

of CUC's Audit Committee, these defendants permitted the falsification of the financial

statements to proceed.

3. Cendant Directors Who Were Former HFS Directors and

Officers

169. Before the merger of CUC and HFS, CUC provided HFS only "limited access

to non-public information concerning CUC's businesses," purportedly because of concern about

56

HFS having access to competitive information should the merger not be consummated. (Report

at 46.) As a result of this limited review of CUC, the Inside Directors of FIFS (defendants

Silverman, Monaco, Holmes, Kunisch and Buckman), as well as its former officers (defendants

Scott Forbes and Ippolito), knew or should have known that they could not rely on their prior

investigations to satisfy their due diligence obligations regarding the Offering. When this is

considered along with CUC's prior history of accounting problems and Walter Forbes's

insistence following the Merger that CUC accounting personnel remain separate from HFS, there

were ample reasons for the HFS inside directors and officers to have been suspicious, or at least

to have undertaken an appropriate investigation that would have revealed the financial manipula-

tions.

170. Questions about CUC's accounting practices surfaced in an event shortly after

the consummation of the Merger and before the issuance of the Registration Statement and

Prospectus. In preparing the December 31, 1997 financial statements for CUC's subsidiary,

CMS, the results for the month of January 1997, which had previously been included in the prior

year's financials, had to be combined with those for the 11 months ended December 31, 1997. In

doing so, CUC had to estimate the January results, as it did not prepare monthly financials in the

ordinary course of business. On behalf of CUC, Sabatino subsequently estimated that CUC's net

after-tax income for January 1997 to be approximately $66 million, an amount substantially

higher than the income for an average month in 1997. (Report at 55.)

171. Ippolito, a former HFS officer, noticed that January 1997 CUC income seemed

high in relation to other months, and specifically discussed it with E&Y and Sabatino prior to

Cendant's Audit Committee meeting to analyze the results. Remarkably, E&Y was unable to

57

confirm the reasonableness of the income figure, instead concluding that it had been overstated

by $23 million, or by more than a third of Sabatino's estimate. At a minimum, this substantial

overstatement should have prompted further investigations by the Individual Defendants,

including the former HFS directors and officers. Had they done so, they should have discovered

what was ultimately revealed in the Report, that the January 1997 results were "contrived to take

advantage of the change to a calendar year and that [Sabatinol had warned Corigliano the

anomaly would be apparent to the auditors." (Report at 56.) Instead, the overstated calculation

was adjusted at Cendant's Audit Committee meeting, which approved Cendant's February 4,

1998 earnings announcement, without further consideration of the implications. An obvious "red

flag" was again ignored.

172. Further red flags arose at that same time when, two days before this

announcement, Scott Forbes received a fax from Corigliano containing revised final 1997

revenues for CUC, both quarterly and by segment. After asking his staff to compare these

revised numbers with those received from CUC a week earlier, Scott Forbes was told on

February 3, 1998, that "{t]here were some significant differences." (Report at 258-59.) Forbes,

however, negligently accepted Corigliano's assertion that these differences "did not materially

affect the bottom line." (Id at 259.) The higher numbers were ultimately included in the

February 4th announcement, without the defendants investigating them to ensure their accuracy.

Later, on April 9, 1998, Sabatino informed Scott Forbes that the upward adjustments "lacked

factual basis," but had been made "to conform the segment results to segment information

presented to analysts in December 1997, which information was also incorrect." (Id.) Sattler,

who provided the segment information for the presentation to the analysts, explained that the

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unsupported segment adjustments were made "to be consistent with the unsupported quarterly

and calendar topside adjustments that had been made." (Id.) Thus, had Scott Forbes not

accepted Corigliano's word and insisted on substantiation, the lack of basis would have been

revealed.

173. Although the warnings that had been recognized by Ippolito and Scott Forbes,

among others, did not prompt the former HFS inside directors and officers to exercise their

responsibility to conduct proper due diligence with respect to CUC's financial statements, they

nevertheless did become suspicious prior to the filing of the Registration Statement and

Prospectus, or at least before the March 2, 1998 consummation of the Offering. Silverman, for

example, was not satisfied with CUC reporting personnel, who after the Merger remained in

charge of consolidating the results of all the CUC subsidiaries. Indeed, by late February,

Silverman actually informed Walter Forbes and Shelton that he "wanted CUC's business units to

switch their reporting from Pember to Scott Forbes" because "[Ole former HFS personnel felt

that they were not getting necessary information and cooperation from CUC Corporate." (Report

at 56-57.) Notwithstanding this clear sign of the need for the HFS personnel to conduct their

own due diligence with respect to CUC's financial statements, Silverman conveniently concurred

with Walter Forbes' and Shelton's request that the change occur after the release of first quarter1

1998 results and the 1997 10-K—and, critically, after the dissemination of the Registration

Statement and Prospectus. (Report at 56-57.)

174. On March 5, only three days after the consummation of the Offering, and a day

before Cendant filed documents with the SEC concerning that consummation, Silverman said

that the "changeover in reporting structure could not wait." (Report at 57.) Walter Forbes and

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Shelton finally acquiesced, with Shelton drafting a memorandum that day stating that, "effective

immediately, Scott Forbes will take responsibility for the consolidation of the numbers from the

former CUC divisions" and that "the reporting function will move from Anne Pember to Scott

Forbes and the divisional CFO's will move their finance reporting relationship directly to Scott."

(Id.) Silverman then instructed Scott Forbes to meet with Shelton on transitional matters. As

already detailed, when Scott Forbes met with CUC officials the next day, he became aware of the

manipulations concerning reserves and immediately informed Silverman and Monaco.

175. After the March 6th meeting, the former HFS officers wanted to know if CUC

had taken merger reserves into income in 1997, and the following day Silverman was informed

by Corigliano that the non-recurring income in the 1997 CUC results could be as high as $100

million. To learn more about this issue, Silverman met with Walter Forbes, Scott Forbes,

Shelton, Monaco and Corigliano on March 8, 1998, and learned that $144 million of CUC's7

1997 net income was attributable to "non-operating" or non-recurring items. Later that day,

Silverman updated defendants Scott Forbes, Monaco, Buckman, Edelman and Holmes on the

0 matter. (Report at 63-64.)

176. By this date, only six days after the consummation of the Offering, and while

there was still time to take action before many of the PRIDES plaintiffs acquired their PRIDES

securities, there was no longer any doubt that the HFS directors and officers had every reason to

suspect the validity of what they had been told by CUC personnel, Yet, they waited for more

than a month before taking further steps—after further damage had been done.

177. As should have been recognized by all Individual Defendants, E&Y might

have placed undue reliance on CUC officials because, as stated, several top CUC officials,

60

including the key players in the accounting fraud, were former E&Y employees. Indeed, CUC

officials were so at ease with successfully continuing their fraud with E&Y as their supposed

watch dog that on March 5, 1998, when Shelton was telling Scott Forbes about his creative ideas

for using merger reserves to inflate income, he requested that E&Y continue its audit of Comp-

U-Card division since that "division was where most of the reserve reversals were scheduled."

(Report at 42, 58.)

178. Prior to the Offering, Silverman and the other former HFS insiders had seen

the red flags and should have pursued appropriate due diligence. They had sufficient reason to at

least inquire further prior to the preparation and dissemination of the Registration Statement and

Prospectus, yet they did nothing. Given the red flags that were present, the former HFS

personnel could not reasonably have relied on the representations of either E&Y or the CUC

insiders and, as such, they are liable under the federal securities laws, as alleged herein.

F. THE NATURE OF THE UNDERWRITER DEFENDANTS'WRONGDOING

179. As was true for the Individual Defendants, the Underwriter Defendants were

also negligent in their failure to conduct appropriate due diligence so as to identify the false

statements in the CUC financials. Importantly, the role of the underwriters is not only to assist

the company in consummating the Offering, but also to ensure that the information being

provided to the public with respect to the securities at issue is fair and accurate. If necessary, the

underwriters must play "devil's advocate" to test the information offered by the company, and

cannot merely rely on the company's assertions without making a reasonable attempt to verify

the data that is submitted to them. Here, the misstatements were so pervasive that the

Underwriter Defendants could not have helped but have noticed potential problems had they but

61

opened their eyes to the need for them to conduct their own investigation so as to satisfy

themselves that the representations being made in the Registration Statement and Prospectus

were accurate and not misleading.

180. Approximately one month before the Offering, Chase provided Cendant with a

$1.5 billion credit facility for the proposed purchase of American Bankers. In fact, Chase

participated as a lead underwriter in the PRIDES Offering because Cendarit's proceeds from the

offering, expected to approximate $1.5 billion, were to repay the credit facility provided by

Chase. Further, Chase performed due diligence regarding the financial performance of Cendant

before closing the credit facility. Prior to the Offering, Chase again had the obligation to perform

a due diligence analysis of Cendant, and its financial condition. Such duplicative and extensive

due diligence inquiries should have provided Chase with information to put it on notice of the

facts that were known or should have been known to the Individual Defendants.

181. In addition, prior to the Offering, Merrill employed one of the foremost

industry analysts that tracked Cendant and, prior to the Merger, CUC. Menill's analyst had

access to top CUC management and closely reviewed Cendant's financial information. Further,

as co-lead underwriter of the PRIDES offering, Merrill had a duty to perform a reasonable due

diligence review. During the period provided for such a review, Merrill had access to top

Cendant management and unfettered access to the Company's financial information. Had Merrill

performed a proper due diligence investigation, such a review should have provided it with

information to put them on notice of the red flags that were known or should have been know to

the Individual Defendants.

7

62

182. Moreover, both Merrill and Chase knew and understood that E&Y did not

audit or certify any CUC financials for the year ending December 31, 1997. Accordingly, neither

Merrill nor Chase could rely on the financial results for the 1997 year and interim periods

contained in the Registration Statement and Prospectus as expertised results.

2

183. By failing to exercise reasonable care in their role as lead underwriters of the

Offering, the Underwriter Defendants are liable under the 1933 Act.

G. THE NATURE OF E&Y'S WRONGDOING

184. E&Y issued unqualified audit opinions ("Audit Opinions") on CUC's financial

statements for fiscal 1996 and 1997, stating that its audits had been performed in conformity with

GAAS and, among other things, that in its opinion such financial statements "present[ed] fairly"

CUC's financial position, result from operation, and changes in financial position in accordance

with GAAP. E&Y's Audit Opinions were materially false and misleading.

185. E&Y's unqualified audit opinions on CUC's financial statements for fiscal

1996 and 1997 were incorporated in the Registration Statement and Prospectus by E&Y's

consent.

186. As set forth above, the financial statements on which E&Y issued its

unqualified opinions contained numerous and material violations of GAAP. The Company has

restated its results for the 1995, 1996 and 1997 calendar years, as well as certain interim quarterly

statements, including for each of the quarters of 1977, as well as the first two quarters of 1998.

Most of the restatement was due to the accounting irregularities that were conducted at CUC and

identified in the Report, which had inflated CUC's operating income, excluding merger and

unusual charges, by over $500 million for these three years.

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It

ri

187. In connection with its audits of CUC and CMS. E&Y conducted audit

examinations and participated in investigations into CUC's business, operations, financial,

accounting and management control systems. In the course of these audits and investigations,

E&Y should have discovered that CUC's financial statements for fiscal 1996 and 1997 were

overstated by material amounts and were not in accordance with GAAP.

188. E&Y had notice of numerous red flags about the accounting irregularities at

CUC.

189. E&Y received the consolidated quarterly results for CUC, which CUC

management had doctored by the already detailed unsupported topside adjustments. CUC did not

send E&Y the quarterly reports of Comp-U-Card that contained the actual results, including

budgets and general ledgers, but sent it such quarterly information for all the other subsidiaries.

(Report at 78.) Comp-U-Card was CUC's largest revenue generator and its largest subsidiary.

E&Y should have noticed this obvious and important gap in the materials that it received and

insisted on examining the Comp-U-Card documents. E&Y substantially departed from GAAS in

not examining this division's quarterly results.

190. More importantly, before the issuance of the Registration Statement and

Prospectus. E&Y had received the actual results of Comp-U-Card through September 1997, in

connection with its special review for the HFS-CUC merger. (Id. at 109 n.11.) Had E&Y

compared these results with those in the consolidated quarterly reports, it should have noticed a

$170 million overstatement of income.

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191. Given this, E&Y should have been alerted to its obligations under SAS Nos.

r) 82, 53 and other GAAS pronouncements detailed below to further examine the financial

statements for fraud for not only 1997, but also 1996 and 1995. As the Report states:

Speaks said that Pember became upset when she learned [inJanuary 1998] that he had provided the September 30. 1997trial balance sheet to E&Y because it effectively precludedComp-U-Card from spreading [certain] revenue adjustmentsback to earlier periods. As a result, Speaks acknowledged,there was a substantial gap (approximately $170 million)between the revenue amounts shown for Comp-U-Card on itsyear-end financial reporting package for the first three quartersof fiscal 199[7] (which did not include the quarterly topsideadjustments discussed earlier in this Report), and the amountsfor that same period reflected on the topside-adjusted con-solidating reports. . . Included among the materials provided byE&Y [to the Audit Committee's investigators] were both thequarterly consolidating reports and the year-end Comp-U-Cardreporting package.

(Report at 109n.111.)

192. E&Y also had notice of certain red flags concerning substantial

understatement of Comp-U-Card's membership reserve in 1995, 1996, and 1997. (Report at

223.) One means utilized by CUC officials to accomplish this related to the posting of

rejects—billings to a member's credit card which were rejected by financial institutions. (Id. at

215.). These rejects were supposed to be charged against the membership reserve. (Id.) Until a

reject was posted in Comp-U-Card's general ledger — i.e., "while the reject [was] 'in transit'"

(Id. at 216)—there would be a difference between what appeared on CUC's books and the

statements from the bank, with the difference shown as a reconciling item on the monthly bank

cash reconciliations compiled with CUC accounting personnel. (Id.) As the Report concluded

"[b]asic accounting procedures would indicate that reconciling items in a bank reconciliation

65

(such as rejects in transit) should be journalized and recorded in the general ledger each month as

they are reported by the bank." (Id. at 217).

193. CUC, however, had a practice, predating 1995, of not writing off any rejects to

the membership reserve for the last three months of each year. (Id.) Instead, CUC "would

'hold' three months of rejects at year-end and book them in the first quarter of the next year."

(Id)

194. In early November 1997, in anticipation of an "early audit sign off" by E&Y

due to the merger of HFS and CUC, the auditor was "scheduled to test cash as of September 30,

1997," much earlier than its usual practice. (Report at 230.) Before such testing, CUC officials

"un-book[ed]" the rejects that had been recorded in the "normal course in July, August and

September, 1997." ( Id.) Thereafter, Comp-U-Card personnel "changed the bank reconciliations

for those months to show the amounts as 'rejects will post." ( Id at 231.) CUC officials then

decided to depart from the practice of holding three months of rejects at year end and instead

decided to "record rejects on a constant three-month lag." ( Id)

195. According to the Report, E&Y had notice of the three month delay in posting

rejects:

The effect of "un-booking" the rejects from July through September was toincrease both cash and Membership Reserve as of September 30, 1997,thereby accomplishing as of that date what traditionally has beenaccomplished by holding the rejects at year-end. This also meant that thebank reconciliations as of September 30 would show large reconciling itemsfor "rejects in transit," representing the unbooked rejects for July, August,and September. For example, the September 30 bank reconciliation for justone account showed unposted rejects totaling more than $30 million for themonth of July through September. . . . Speaks said that E&Y wasaccustomed to seeing these reconciling items when it audited cash at prioryear-ends. Indeed, the following notation appears in E&Y's work papersfor the cash confirmation period it performed at September 30. 1977:

66

It should be noted that significant reconciling activity stemmed from July1997 and forward, due to the fact CUC records rejects 3 months in arrears.,as is Company policy.

(Id at 231-32; emphasis added.)

196. E&Y's Rabinowitz, the partner in charge of its audits (Report at 27), initialed

the work paper referred to in the Report. ( Id at 232.) Furthermore, "one of the E&Y auditors

noticed the rejects in transit and questioned Speaks about it during E&Y's September 30 audit of

cash." (Id.) Speaks informed her that "the company's policy was to hold those rejects for three

months before booking them, and that this had always been the policy." (Id.) E&Y, however,

did not have any follow-up conversation with Speaks. (Id)

2197. E&Y further had notice of certain inflation of income. For example, for the

month of January 1997, CUC had income of $66 million, "an amount substantially higher than

the income for an average month in 1997," (Report at 55.). As a CUC official later told the

Audit Committee's investigators, "the January 1997 results were contrived to take advantage of

the change to a calendar year and that he had warned Corigliano the anomaly would be apparent

to the auditors." Id. at 56. Due to E&Y's negligence, however, the auditor did not sufficiently

respond to this "apparent" red flag.

198. E&Y was unable "to confirm the reasonableness" of a substantial part of the

net income figure for this month, in the "high 20's of millions of dollars," but nevertheless

reported to Cendant's Audit Committee on February 3, 1998 that the overstatement was not

n material, (Report at 55; 56 n.55.) But for E&Y's negligence, it would have realized that the

overstatement was due to accounting irregularities inconsistent with GAAP. Its conclusion that

the overstatement resulted from an inadvertent "error" and "judgmental differences" was

67

influenced by its undue reliance, without sufficient verification, on CUC's officials'

explanations, including that the unusually high January 1997 results were due to one time events.

(Id at 55, 56.).

199. E&Y also had general notice of the mismatching of revenues and expenses at

Comp-U-Card—the immediate recognizing of revenues but deferral of expenses. Although

CUC's stated policy was to recognize all membership fees ratably over the membership period,

in practice there were some programs, such as Privacy Guard and Dining, where Comp-U-Card

recognized all the revenues on an immediate basis at the time the member joined. Approximately

21% of Comp-U-Card's total membership revenues in 1997 were derived from such immediate

recognition programs. (Report at 200). As the Report observed:

Rabinowitz of E&Y said he understood Comp-U-Card'spolicy was to amortize revenues generally over the life of themembership, and expenses on a weighted average basis overthe life of the membership. He was aware that certain programssuch as Privacy Guard, Warranty and Health recognizedrevenue for new members on an immediate basis, and thatComp-U-Card did not recognize new solicitation expensesimmediately on these programs. He said he understood thatoverall, on a weighted average basis, there was a matching ofexpenses and revenues.

(Id at 204-05, footnote omitted.)

200. In coming to this conclusion about overall matching, E&Y again accepted,

without adequate verification, CUC officials' representations. While conducting its audits for the

fiscal year ended January 31, 1997 and for the year ended December 31, 1998, E&Y did not

request CUC to perform any analysis to verify that in actuality there was such overall matching.

(Report at 205, 206 n.182.) Had it requested such information, it would have discovered that

there was substantial mismatching. (Id at 205.) Such knowledge would have alerted it to

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scrutinize more carefully CUC's entire revenue recognition practices and policies and reveal the

GAAP improprieties, such as the CUC official's reallocation of Comp-U-Card's revenues from

one program to another to get immediate revenue from what would otherwise have been a

deferred source. (Id. at 209-10.)

201. E&Y also had reason to suspect the improper use of merger reserves. The

Ideon Reserve was created by CUC by taking a special charge of $179.9 million in early 1997 for

the year ended Januaiy 31, 1997, for certain merger, integration and litigation costs, with $70 to

$90 million reserved for litigation costs. (Report at 38-39, 41.) During its audit of the December

31, 1997 financial statements of CMS, E&Y was informed that only $18 million of litigation

expenses had been charged to the Ideon Reserve but that CUC had experienced greater than

expected merger integrations costs and therefore it had reallocated the merger reserves for this

purpose. (Id. at 41).

202. E&Y accepted, without independent verification, an explanation provided by

Corigliano, its former employee. (See Report at 43-44.) In fact, on January 17, 1998, $63

million of the Ideon Reserves were reversed into operating income for the year ended December

31, 1997, "without factual justification or support," (id. at 103; see also 42, 118) "not supported

by adequate (or any) documentation," and "not understandable in terms of accepted accounting

practices. (Id at 142).

203. Indeed, during its audit of CMS' financials for December 31, 1997, E&Y was

on notice that by the end of 1997. CUC had essentially utilized the entire &179.9 million Ideon

Reserve created only eleven months before. As the Report stated, "E&Y had not obtained

documentary support" for at least $25 million of this utilization. (Report at 65.) It nevertheless

69

!,)

concluded that this amount was not material. (Id.). The conclusion was without any reasonable

basis

204. E&Y placed undue reliance on CUC officials because, as already stated,

several top CUC officials, including certain key players in the accounting fraud, were former

E&Y employees. They included Corigliano, Kearney, Pember, and Sattler. (Report at 26.)

Indeed, CUC officials were so at ease with successfully continuing their fraud with E&Y as their

supposed watch dog that on March 5, 1998, when Shelton was telling Scott Forbes about his

creative ideas for using merger reserves to inflate income, he requested that E&Y continue its

audit of Comp-U-Card division since that "division was where most of the reserve reversals were

scheduled." ( Id. at 42, 58.)

205. Had E&Y conducted its audits in conformity with GAAS, it would have

discovered the accounting irregularities that resulted in CUC issuing materially false and

misleading financial statements for fiscal 1996 and 1997. E&Y's representation in the Audit

Opinions that its audits were in accordance with GAAS were false and misleading for, among

1 others, the following reasons:

A. E&Y violated GAAS General Standard No. 3 that requires that due pro-fessional care must be exercised by the auditor in the performance of theaudit and the preparation of the report;

B. E&Y violated GAAS Standard of Field Work No. 2 that requires theauditor to make a proper study of existing internal controls, includingaccounting, financial and managerial controls, to determine whetherreliance on those controls was justified, and if such controls are notreliable, to expand the nature and scope of the auditing procedures to beapplied;

C. E&Y violated GAAS Standard of Field Work No. 3 that requires suffi-cient, competent evidential matter to be obtained through inspection,

70

observation, inquiries and confirmations to afford a reasonable basis foran opinion regarding the financial statements under audit.;

D. E&Y violated GAAS Standard of Reporting No. 1 which requires theauditor, in preparing the report, to state whether the financial statementsare presented in accordance with GAAP; and

E. E&Y violated GAAS Standard of Reporting No. 4 which requires, whenan opinion cannot be expressed regarding the financial statements as awhole, that the auditor state in the audit report the reasons why suchopinion cannot be expressed. E&Y should have stated that it couldexpress no opinion as to the financial statements or issued an adverseopinion and stated that the financial statements were not in accordancewith GAAP.

206. In addition, E&Y failed to adhere to at least the following statements of

Auditing Standards:

A. SAS No. 31, which requires that an auditor obtain all corroboratinginformation to support the financial statements being audited includingchecks, invoices, contracts, minutes of meetings, confirmations or otherwritten representations by knowledgeable people, and informationobtained from independent sources;

B. SAS No. 67, which requires that an auditor establish and perform aconfirmation process with third parties to verify information utilized inthe audit models; and

1

C. SAS No. 19, which requires that an auditor not substitute clientrepresentations for audit procedures necessary to form a reasonable basisas to the opinion being given on financial statements.

207. In February 1997, the American Institute of Certified Public Accountants

(AICPA) issued a new standard in the area of fraudulent financial reporting. Statement on

Auditing Standards No. 82, "Consideration of Fraud in a Financial Statement Audit" (SAS 82),

which is effective for periods ending on or after December 15, 1997 (in the case of CUC, SAS 82

applies to calendar 1997).

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208. This pronouncement points out that the primary factor that distinguishes

accounting fraud from error is whether the underlying action that results in the misstatement in

financial statements is intentional or unintentional. SAS 82 contains the following definition:

"Misstatements arising from fraudulent financial reporting are intentional misstatements or

omissions of amounts or disclosures in financial statements to deceive financial statement users.

Fraudulent financial reporting may involve acts such as the following:

A. manipulation, falsification, or alteration of accounting records orsupporting documents from which financial statements are prepared;

B. misrepresentation in, or intentional omission from, the financialstatements of events, transactions, or other significant informationquantifying accounting irregularities. During the investigation certainmisstatements were identified; and

C. intentional misapplication of accounting principles relating to amounts,classification, manner of presentation, or disclosure."

209. Prior to SAS 82, the relevant standard was contained in Statement on Auditing

Standards No. 53, "The Auditor's Responsibility to Detect and Report Errors and Irregularities"

(SAS 53), which had been effective for periods beginning on or after January 1, 1989 (in the case1

of CUC, SAS 53 applies to fiscal 1996 and fiscal 1997). This pronouncement also makes the

same distinction (based on intent) between accounting errors and "irregularities." SAS 53

defines the term "irregularities" as follows: "The term 'irregularities' refers to intentional

misstatements or omissions of amounts or disclosures in financial statements. Irregularities

include fraudulent financial reporting undertaken to render financial statements misleading,

sometimes called management fraud, and misappropriation of assets, sometimes called

defalcations. Irregularities may involve acts such as the following:

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A. manipulation, falsification, or alteration of accounting records orsupporting documents from which financial statements are prepared;

B. misrepresentation or intentional omission of events, transactions, or othersignificant information; and

C. intentional misapplication of accounting principles relating to amounts,classification, manner of presentation, or disclosure.

210. The controlling GAAS standard for examination and reporting of irregularities

prior to fiscal 1997 is SAS No. 53, entitled "THE AUDITORS RESPONSIBILITY TO DETECT

AND REPORT ERRORS AND IRREGULARITIES," which states in relevant part:

[53.03] The term irregularities refers to intentional misstate-ments or omissions of amounts or disclosures in financialstatements. Irregularities include fraudulent financial reportingundertaken to render financial statements misleading,sometimes called management fraud. .

[53.05] The auditor should assess the risk that errors andirregularities may cause the financial statements to contain amaterial misstatement. Based on that assessment, the auditorshould design the audit to provide reasonable assurance ofdetecting errors and irregularities that are material to thefinancial statements. [N-3] The auditor's responsibilities fordetecting misstatements resulting from illegal acts, as definedin SAS No. 54, Illegal Acts by Clients, having a direct andmaterial effect on the determination of financial statementamounts is the same as that for other errors and irregularities.

211. While neither the allegation nor establishment of fraud is necessary to the

claims of the 1933 Act Class, the Report in fact has concluded that CUC's financial statements

for the 1995 through 1997 period overstated operating income, prior to merger and unusual

charges, by $500 due to "accounting irregularities' which met "the SAS 82 and SAS 53

definitions of `fraudulent financial reporting' and 'irregularities,' respectively, within the

applicable time periods." (Report at 7-8 n.9.) E&Y substantially departed from compliance

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1

with SAS Nos. 82 and 53, as it was negligent in not knowing of these "fraudulent financial

reporting" and "irregularities," including the unsupported top side adjustments, irregularities

involving reversals of merger reserves into income, other improper utilization of merger reserves,

irregularities in connection with revenue recognition, irregularities concerning the membership

cancellation reserve and the other irregularities identified in the Report.

212. In addition, under the SEA, 10A, the auditor must also detect and report fraud

under certain circumstances. Section 10A of the SEA, entitled "AUDIT REQUIREMENTS"

essentially codifies SAS Nos. 53 and 54, and states in relevant part:

(i) In General - Each audit required pursuant to this title of thefinancial statements of an issuer by an independent publicaccountant shall include, in accordance with generallyaccepted auditing standards, as may be modified orsupplemented from time to time by the Commission.

1) procedures designed to provide reasonable assurance ofdetective illegal acts that would have a direct andmaterial effect on the determination of financialstatement amounts.

2) procedures designed to identify related partytransactions that are material to the financialstatements or otherwise require disclosuretherein; and

3) an evaluation of whether there is substantial doubtabout the ability of the issuer to continue as a goingconcern during the ensuing fiscal year.

213. The controlling standard under GAAS for the examination and reporting of

illegal acts such as the Foreign Corrupt Practices Act, is SAS No. 54, "ILLEGAL ACTS BY

CLIENTS," which states in relevant part as follows:

[SAS 54.02] The term illegal acts, for purposes of this State-nrient, refers to violations °flaws or governmental regulations.

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L'

Illegal acts are acts attributable to the entity whose financialstatements are under audit or acts by management or employeesacting on behalf of the entity.

[SAS 54.05] The auditor considers laws and regulations thatare generally recognized by auditors to have a direct andmaterial effect on the determination of financial statementamounts. For example, tax laws affect accruals and the amountrecognized as expense in the accounting period . . . Theauditor's responsibility to detect and report misstatementsresulting from illegal acts having a direct and material effect onthe determination of financial statement amounts is the same asthat for errors and irregularities as described in SAS No. 53 . . .

[SAS 54.08] . . [Procedures applied for the purposes offorming an opinion on the financial statements may bringpossible illegal acts to the auditor's attention. For example,such procedures include reading minutes; inquiring of theclient's management and legal counsel concerning litigation,claims, and assessments; performing substantive tests of detailsof transactions or balances . . .

[SAS 54.09] In applying audit procedures and evaluating theresults of those procedures, the auditor may encounter specificinformation that may raise a question concerning possibleillegal acts, such as the following:

Unauthorized transactions, improperly recorded transactions,or transactions not recorded in a complete or timely manner inorder to maintain accountability for assets[;] Failure to file taxreturns or pay governmental duties or similar fees that arecommon to the entity's industry or the nature of its business,

The Auditor's Consideration of Financial Statement Effect

[SAS 54.14] The auditor should consider the effect of an illegalact on the amounts presented in financial statements includingcontingent monetary effects, such as fines, penalties anddamages. Loss contingencies resulting from illegal acts thatmay be required to be disclosed should be evaluated in thesame manner as other loss contingencies.

75

[SAS 54.16] The auditor should consider the implications of anillegal act in relation to other aspects of the audit, particularlythe reliability of representations of management.

[SAS 54.18] If the auditor concludes that an illegal act has amaterial effect on the financial statements, and the act has notbeen properly accounted for or disclosed, the auditor shouldexpress a qualified or adverse opinion on the financialstatements taken as a whole. . .

[SAS 54.19] If the auditor is precluded by the client fromobtaining sufficient competent evidential matter to evaluatewhether an illegal act that could be material to the financialstatements has, or is likely to have, occurred, the auditor shouldgenerally disclaim an opinion on the financial statements.

[SAS 54.20] If the client refuses to accept the auditor's reportas modified for the [illegal act], the auditor should withdrawfrom the engagement and indicate the reasons for thewithdrawal in writing to the audit committee or board ofdirectors.

[SAS 54.23] . . . The auditor should recognize, however, thatin the following circumstances a duty to notify parties outsidethe client may exit: a. When the entity reports an auditorchange under the appropriate securities law on Form 8-K.

214. E&Y substantially departed from compliance with SAS No. 54, as it was

negligent in not knowing of CUC's improper accounting and disclosures of CUC's accounting

irregularities as complained of herein.

215. E&Y substantially departed from GAAS in that it was negligent in not

knowing that CUC also violated the Foreign Corrupt Practices Act of 1977 ("FCPA"), which

imposes certain accounting requirements on public corporations. Specifically, Section 102,

"Accounting Standards," states that public corporations shall:

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(i) make and keep books, records, and accounts, which, inreasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of issuer; and

(ii) devise and maintain a system of internal accounting controlssufficient to provide reasonable assurances that:

1) transactions are executed in accordance withmanagement's general or specific authorization; and

2) transactions are recorded as necessary to permitpreparation of financial statements in conformity withgenerally accepted accounting principles or any othercriteria applicable to such statements...".

216. E&Y further substantially departed from GAAS by either not detecting or not

reporting CUC's and defendants' audit committees material internal control weaknesses as

required by SAS Nos. 55, 60 and 78:

SAS No. 55 requires the auditor to obtain a sufficientunderstanding of the control environment, risk assessment,control activities, information and communication, andmonitoring to plan the audit. This understanding of internalcontrol components should be used to - (a) identify types ofpotential misstatements; (b) Consider factors that affect therisk of material misstatement; and (c) design substantivetests. [SAS No. 78, lj 1.121

During the course of an audit, the auditor may become awareof matters relating to the internal control structure that maybe of interest to the audit committee. The matters that this Statement requires for reporting to the audit committee arereferred to as reportable conditions. Specifically, these arematters coming to the auditor's attention that, in hisjudgment, should be communicated to the audit committeewhich because they represent significant deficiencies in thedesign or operation of the internal control structure, whichcould adversely affect the organization's ability to record,process, summarize, and report financial data consistent withthe assertions of management in the financial statements.[SAS. No. 60.]

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(Emphasis added.)

217. As explained in more detail above, the Report concluded that there were

material internal control weaknesses at CUC throughout the 1995-1997 period, all of which were

permitted by E&Y and were not reported by E&Y.

VI. CLAIMS UNDER THE SECURITIES ACT OF 1933

FIRST CLAIM FOR RELIEF(Against the Cendant Defendants for

Violations of Section 11 of the Securities Act)

218. This claim is brought against the Cendant Defendants pursuant to Section 11 of

the 1933 Act on behalf of the 1933 Act Class—all purchasers or acquirers of the PRIDES during

February 24, 1998 through April 15, 1998 period. This claim does not sound in fraud, and

neither fraud nor scienter is an element of this claim.

219. Plaintiffs and the other members of the 1933 Act Class purchased or acquired

PRIDES issued pursuant to, or traceable to, the Registration Statement. The Registration

Statement, at the time it became effective, was inaccurate and misleading, contained untrue

statements of material fact and/or omitted to state material facts necessary to make the statements

made therein not misleading, as set forth above. The matters detailed above would have been

material to a reasonable person reviewing the Registration Statements and the financial

statements incorporated therein.

220. Cendant and Cendant Capital 1 were identified in the Registration Statement

and Prospectus as the issuers of the PRIDES, and are the issuers of this Offering within the

meaning of Section 11 of the Securities Act. As such, they are strictly liable for the

misstatements and omissions of material fact contained in the Registration Statement and

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Prospectus regardless of whether or not they acted negligently. Their liability is joint and

several.

221. Plaintiffs and the other members of the 1933 Act Class did not know or in the

exercise of reasonable diligence could not have known of the untruths and omissions contained

in the Registration Statement and Prospectus.

222. Plaintiff and the other members of the 1933 Act Class have sustained damages

as a result of the misstatements and omissions contained in the Registration Statement and

Prospectus for which they are entitled to compensation.

223. Less than one year has elapsed from the time that plaintiff discovered or

reasonably could have discovered the facts upon which this Complaint is based to the time of

filing this Complaint. Less than three years has elapsed from the time that the securities upon

which this Count is brought were offered to the public to the time of filing this Complaint.

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SECOND CLAIM FOR RELIEF(Against the Individual Defendants

for Violations of Section 11 of the Securities Act)

224. This claim is brought pursuant to Section 11 of the 1933 Act on behalf of the

1933 Act Class. This claim does not sound in fraud, and neither fraud nor scienter is an element

of this claim.

225. Plaintiffs and other members of the 1933 Act Class purchased or acquired

PRIDES issued pursuant to, or traceable to, the Registration Statement. The Registration0

Statement, at the time it became effective, was inaccurate and misleading, contained untrue

statements of material fact and/or omitted to state material facts necessary to make the statements

made therein not misleading, as set forth above. The matters detailed above would have been

material to a reasonable person reviewing the Registration Statements and the financial

statements incorporated therein.

226. The Registration Statement and Prospectus was inaccurate and misleading,

contained untrue statements of material fact, omitted other facts necessary to make the statements

made not misleading, and failed to disclose adequately material facts as described above.

227. The Individual Defendants named in this action either personally or through an

attorney-in-fact signed the Registration Statement and Prospectus and/or were directors of

Cendant at the time of its issuance. Due to their signing of the Registration Statement and

Prospectus or status as directors, the Individual Director Defendants were responsible for the

contents and dissemination of the Registration Statement and the Prospectus and are liable under

Section 11 of the Securities Act for any material misrepresentations or omissions contained

therein. The Individual Defendants did not make a reasonable investigation and did not possess

80

reasonable grounds for believing that the statements contained in the Registration Statement and

Prospectus were true, did not omit any material facts and were not materially misleading.

228. Plaintiffs and the other members of the 1933 Act Class did not know or in the

exercise of reasonable diligence could not have known of the untruths and omissions contained

in the Registration Statement and Prospectus.

229. As a result of the Individual Defendants' violation of Section 11, plaintiff and

other member of the 1933 Act Class have sustained damages for which they are entitled to

compensation.

230. As already detailed, this claim has been timely asserted and there are no statute

1of limitations problems.

THIRD CLAIM FOR RELIEF(Against E&Y For Violations ofSection 11 of the Securities Act)

231. This claim is brought pursuant to Section 11 of the 1933 Act on behalf of the

1933 Act Class. This claim does not sound in fraud, and neither fraud nor scienter is an element

of this claim.

232. E&Y is an independent certified public accountant retained by CUC to, among

other things, audit CUC's fiscal 1996 and 1997 financial statements and conduct reviews of its

quarterly statements. Pursuant to that retention, E&Y issued unqualified opinions validating

CUC's financial statements for fiscal years 1996 and 1997.

233. E&Y expressly consented to having its unqualified audit opinions for CLIC's

fiscal years 1996 and 1997 incorporated by reference into the Registration Statement and

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Prospectus. As such, E&Y expressly consented to serving as an accounting "expert" with respect

to the Offering.Pi)

234. The PRIDES were purchased by plaintiffs and the other members of the 1933

Act Class pursuant to or traceable to the Registration Statement.

235. E&Y's unqualified opinions on CUC's fiscal 1996 and 1997 financial

statements were materially false and misleading. Contrary to its representation therein, E&Y's

audit of those financial statements had not been conducted in accordance with GAAS, and

CUC's financial condition and results of operations had not been presented fairly and accurately

in conformity with GAAP, as set forth above. Rather, CUC's audited fiscal 1996 and 1997

financial statements contained untrue statements of material facts and failed to state other facts

necessary to make the statements made not misleading, and were in extreme departure from

GAAP, as set forth above.

236. As an accounting expert which consented to the use of its unqualified audit

opinions in the Registration Statement and Prospectus, E&Y is liable under Section 11 of the

1 1933 Act for the material misrepresentations or omissions contained in its unqualified audit

opinions and in the CUC financial statements for fiscal 1996 and 1997, which were reflected in

Cendant's consolidated financial statements for 1995 and 1996 reported in the Registration

Statement and Prospectus. E&Y did not make a reasonable investigation and did not possess

reasonable grounds for believing that its representations in its audit opinions and CUC financial

statements for fiscal 1996 and 1997 were true, did not omit any material facts and were not

materially misleading.

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237. Plaintiffs and the other members of the 1933 Act Class did not know or in the

exercise of reasonable diligence could not have known of the untruths and omissions contained

in the Registration Statement and Prospectus.

238. Plaintiff and the other members of the 1933 Act Class have sustained damages

as a result of the material misrepresentations and omissions contained in the Registration

Statement and Prospectus, as detailed in this claim.

239. Plaintiffs have timely asserted this claim against E&Y, as already detailed.

FOURTH CLAIM FOR RELIEF(Against the Underwriter Defendants

For Violations of Section II of the Securities Act)

240. This claim is brought against the Underwriter Defendants pursuant to Section

11 of the 1933 Act on behalf of the 1933 Act Class. This claim does not sound in fraud, and

neither fraud nor scienter is an element of this claim.

241. The Underwriter Defendants participated in the solicitation, offering, and sale

of PRIDES to the investing public pursuant to the Registration Statement. The 1933 Act Class

purchased or acquired PRIDES issued pursuant to, or traceable to, the Registration Statement.

242. The Registration Statement, at the time it became effective, was inaccurate and

misleading, contained untrue statements of material fact and/or omitted to state material facts

necessary to make the statements made therein not misleading, as set forth above. The matters

detailed above would have been material to a reasonable person reviewing the Registration

Statement and the financial statements incorporated therein.

243. Due to their role as lead underwriters of the Offering, the Underwriter

Defendants were responsible for the contents and dissemination of the Registration Statement

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and the Prospectus and are liable under Section 11 of the 1933 Act for the material

misrepresentations or omissions contained therein. The Underwriter Defendants did not make a

reasonable investigation and did not possess reasonable grounds for believing that the statements

contained in the Registration Statement and Prospectus were true, did not omit any material facts

and were not materially misleading.

244. Plaintiffs and the other members of the 1933 Act Class did not know or in the

exercise of reasonable diligence could not have known of the untruths and omissions contained

in the Registration Statement and Prospectus at the time they purchased or acquired the PRIDES.

245. Plaintiffs and the other members of the 1933 Act Class have sustained damages

a result of the material misrepresentations and omissions contained in the Registration Statement

and Prospectus.

246. Plaintiffs have timely asserted this claim against the Underwriter Defendants,)

as already detailed.

FIFTH CLAIM FOR RELIEF(Against the Cendant Defendants and the Underwriter

Defendants For Violations of Section 12(a)(2) of the Securities Act)

247. This claim is brought against the Cendant Defendants and the Underwriter

Defendants pursuant to Section 12(a)(2) of the Securities Act on behalf of the 1933 Act Class.

This claim does not sound in fraud, and neither fraud nor scienter is an element of this claim.

248. Cendant Defendants and the Underwriter Defendants either sold the PRIDES

issued pursuant to the Registration Statement and Prospectus directly to plaintiffs and the other

members of the 1933 Act Class or solicited these class members to purchase or acquired such

securities and, therefore, these defendants are sellers of such securities as defined under Section

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12(a)(2) of the 1933 Act. Defendants' actions of solicitation included participating in the

preparation of the false and misleading Registration Statement.

249. The Registration Statement contained untrue statements of material facts,

omitted to state other facts necessary to make the statements made not misleading, and concealed

and failed to disclose material facts, as set forth above.

250. The Cendant Defendants and the Underwriter Defendants did not, as set forth

above, make a reasonable investigation and did not possess reasonable grounds for believing that1

the statements contained in the Registration Statement and Prospectus were true, did not omit

any material facts and were not materially misleading.

251. Plaintiffs and the other members of the 1933 Act Class did not know or in the1

exercise of reasonable diligence could not have known of the untruths and omissions contained

in the Registration Statement and Prospectus.1

252. Plaintiff, individually and representatively, hereby offers to tender to the

defendants named in this claim the PRIDES which plaintiff and the other 1933 Act Class

members purchased on the Offering and continue to own, on behalf of all members of the 1933

Act Class similarly situated, in return for the consideration paid for those securities together with

interest thereon, or, alternatively, seek and are entitled to rescissory damages.

253. Plaintiffs have timely filed this claim, as already detailed.

254. Plaintiffs and the other 1933 Act Class members have no adequate remedy at

law.

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SIXTH CLAIM FOR RELIEF(Against the Individual Defendants

for Violation of Section 15 of the Securities Act)

255. This claim is brought pursuant to Section 15 of the Securities Act on behalf of

the 1933 Act Class. This claim does not sound in fraud, and neither fraud nor scienter is an

element of this claim.

256. Each of the Individual Defendants, by virtue of their executive and directorial

positions and stock ownership had the power, and exercised same, to control the representations

and actions of Cendant. As such, each of them is liable for Cendant's violations of Sections 11

and 12(2) of the 1933 Act by its issuance of a materially false and misleading Registration

Statement and Prospectus as a "control person" pursuant to Section 15 of the Securities Act.

ALLEGATIONS RELATING TO THE EXCHANGE ACT CLAIMS

257. All previously stated allegations are hereby incorporated in this section of the

Second Amended Complaint as if fully and completely set forth herein.

VH. INTRODUCTION TO THE EXCHANGE ACT CLAIMS

258. From approximately 1983 until May 11, 1998, Ernst & Young provided

accounting services to CUC (later Cendant), including audits of CUC's and CMS's annual

financial statements for filing with the SEC in Form 10-Ks. Ernst & Young audited and issued

unqualified reports on all the financial statements relating to CUC and CMS that are the subject

of this action. (Cendant Membership Services, Inc. ("CMS") is the subsidiary of Cendant that

took over most of the former CUC operations after the merger.)

259. E&Y also conducted pre-filing reviews of the quarterly financial statements

that CUC filed with the SEC in its Form 10-Qs for the first three quarters of CUC's Fiscal Years)

86

ending January 31, 1996, January 31, 1997, and January 31, 1998, and rendered opinions thereon

(except for the third quarter of Fiscal Year 1998).

260. On March 31, 1998, Cendant filed with the SEC, in a Form 10-K, audited

consolidated financial statements for the year ending December 31, 1997. The portion of those

consolidated financial statements relating to the business of CUC and its successor CMS were

audited by E&Y, which had agreed to audit the CUC and CMS statements in accordance with

GAAS. They were accompanied by an audit report dated February 3, 1998, in which E&Y stated

that it had conducted its audit in accordance with GAAS and that Cendant's financial statements

"present fairly, in all material respects," the consolidated financial results of CMS for the year

ended December 31, 1997 and for CUC for the year ended January 31, 1997, "in conformity with

generally accepted accounting principles." (The Form 10-K filed on March 31, 1998 is Exhibit

D in the accompanying Appendix.) The Form 10-K was signed, through their attorneys-in-fact

and agents, by defendants Forbes, Shelton, Silverman, McLeod, Tucker and others. (Id. at 50-

51.))

261. As detailed above, Cendant released some information about the restatement of

its financial reporting for 1997 in a press release on April 15, 1998. As particularized herein,

) however, the April 15th announcement was not complete or accurate, and was itself fraudulent

and misleading. As such, the market was only able to partially discount the price of the PRIDES

and the Cendant common stock to account for the anticipated restatement. Thus, when plaintiffs)

acquired PRIDES during the Exchange Act Class Period, they did so at prices that continued to

be artificially inflated, because of the defendants' failure to disclose fully the extent of the fraud.

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5

262. E&Y assisted Cendant in preparing the information released to the public on

rd April 15th. In doing so, E&Y knew or deliberately and recklessly ignored the fact that Cendant's

disclosures were inadequate and materially misleading. Nevertheless, E&Y failed to ensure that

appropriate disclosures were made or that proper corrections were issued, in violation of its

obligations under GAAS. As such, E&Y cannot now claim immunity from liability under the

federal securities laws as a result of that partial and misleading disclosure.

263. On July 14, 1998, based upon information developed from an independent

investigation commissioned by the audit committee of the Cendant board of directors, Cendant

finally disclosed that the accounting irregularities were far more pervasive than had been

previously disclosed and resulted in an overstatement of net income for 1997 that was more than

double the amount announced on April 15, 1998, i.e. over $200 million. It further acknowledged

that net income for 1995 and 1996 had been inflated by approximately $250 million (pre-tax) and

that it would be restating its financial reports for the prior three years, from 1995 through 1997.

264. This disclosure caused additional substantial decline in the value of both the)

PRIDES and the Cendant common stock. Until this announcement, the market was unable to

fully discount the amount by which the price of the PRIDES and the Cendant common stock had

been artificially inflated by the false and misleading financial statements described herein.

265. On August 27, 1998, Cendant issued a press release announcing the

presentation to the Board of Directors of the Report. Cendant stated that the accounting

)irregularities detailed by the Report constituted "fraudulent financial reporting" undertaken in an

attempt to appear to meet analyst's predictions of corporate earnings. In addition, Cendant stated

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that more than one-third of CUC's total income for the three year period from 1995 through 1997

"was deliberately and fictitiously manufactured."

266. Cendant filed the Report with the SEC on August 28, 1998. The Report

concluded that six individual CUC financial executives, including the Chief Financial Officer of

CUC, directly participated in the fraud, the purpose of which was to appear to meet the earnings

expectations of Wall Street analysts.

267. Cendant's Audit Committee, as reported in the Form 8-K of August 28, 1998,

also concluded, on the basis of the Report, that Cendant CEO and Chairman Walter Forbes, and

CUC President and COO E. Kirk Shelton should also be held responsible for the irregularities.

268. On September 29, 1998, the Company filed with the SEC a Form 10-K/A

restating "its previously reported financial results for 1997, 1996 and 1995." The restatement

showed that the revenues and net income for this period that were reported in the Registration

Statement and Prospectus, and CUC's Form 10-Ks for the Fiscal Years 1997 and 1996, and

Cendant's Form 10-K for the year ended December 31, 1997, had been inflated, in total, by over

$2.1 billion. Further illustrating the magnitude of the difference between the financial picture

presented by CUC's and Cendant's financial statements and the actual facts, in 1997 Cendant had

a loss of $217.2 million rather than the reported net income of $55.4 million.)

269. In October 1998, the Company also restated its results for the first two quarters

of 1998 and the four quarters of 1997.

)

270. On January 25, 1999, Cendant filed a Complaint against Ernst & Young in this

Court (the "Cendant Complaint") in which the Company admitted the falsity of its financial

statements as detailed herein and in the Report, and alleged that E&Y's purported audits of the

89

)

CUC and CMS financial statements, and the resulting unqualified audit reports, constituted

"gross negligence and fraudulent conduct." (Cendant Complaint, 124.) Cendant charges that

E&Y "knew its audit reports were false or it recklessly disregarded whether they were false or

not." (Id., ir[ 160.) (The Cendant Complaint is Exhibit 0 in the accompanying Appendix.)

271. The Exchange Act Claims are brought on behalf of all purchasers of PRIDES

between April 16, 1998 and July 13, 1998, inclusive, pursuant to Sections 10(b) and 20(a) of the

Exchange Act, and Rule 10b-5 promulgated thereunder.

A. THE CONTINUING FRAUD: REPRESENTATIONS MADE ONAND AFTER APRIL 15, 1998

272. In the April 15. 1998 announcement, and thereafter until July 14, 1998,

Cendant and the Exchange Act Individual Defendants (except Corigliano), as well as E&Y,

intentionally or recklessly misled the market in an effort to sustain the price of Cendant common

stock (and, as a result, the PRIDES) so as to keep alive the possibility of Cendant consummating

its merger with American Bankers. In so doing, the Defendants artificially inflated the price of

the PRIDES such that members of the Class who acquired these securities during the Class

Period paid more than they were worth and were damaged thereby. Only with the July 14, 1998

announcement, reporting the full extent of the misstatements in Cendant's financial reports, did

0the market begin to accurately value the Cendant common stock and the PRIDES.

273. When Cendant issued its April 15, 1998 press release to announce its

anticipated restatement of its previously issued reports for 1997, it minimized the significance of

the "accounting irregularities" so as to reduce the anticipated adverse reaction from the market.

For example, when describing the significance of the problem, it stated:

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[Cendant] has discovered potential accounting irregularities in certainformer CUC business units which are part of Cendant's AllianceMarketing division (formerly the Membership segment). Accordingly,Cendant said it expects to restate annual and quarterly net income andearnings per share for 1997 and may restate certain other previousperiods related to the former CUC businesses.

Based on presently available information, the effect on 1997 results isexpected to be a reduction to net income prior to restructuring andunusual charges of approximately $100 to $115 million and earnings pershare by about 11 to 13 cents, respectively. . . .

Cendant said that the potential accounting irregularities are limited tocertain former CUC businesses, which accounted for less than one thirdin Cendant's net income in 1997. It said all its current businessescontinue to perform strongly and that its anticipated percentage growth ofearnings per share in 1998 over restated 1997 appeared achievable.Cendant expects to meet or exceed the currently forecasted Wall Streetconsensus estimate of 25 cents per share for the first quarter of 1998.

(Emphasis added.) (A copy of the press release, contained in a Form 8-K filed with the SEC on

April 17, 1998, is Exhibit F in the accompanying Appendix).

274. Thus, Cendant stated that the accounting irregularities were only "potential,"

not "actual," that the number of business units affected by the potential "accounting

irregularities" were small, that it expected the restatement to total approximately $100 to $115

million, and that, notwithstanding the anticipated restatement, the Company continued to expect

to "perform strongly." (Id)

275. Although Cendant included a disclaimer in its release that, "[i]n accordance

with SAS No. 1, the Company's previously issued financial statements and auditors' reports

should not be relied upon," this warning was buried in the last substantive paragraph of the three-

page release, immediately prior to its boilerplate company description and "forward looking

statements" paragraph. (Id.) When viewed in conjunction with the information describing the

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limited nature of the purported misstatements, the disclaimer served only to inform the market

that the prior financial statements and audit reports should be discounted by the identified

amounts -- i.e., a reduction of net income of up to $115 million -- not that they should be ignored

in their entirety.

276. Furthermore, Cendant quoted defendant Silverman as stating: "Cendant

remains a very strong and highly liquid company. Our businesses are very healthy and growing,

but we're growing off a lower base than we had been previously led to believe by certain

members of the former CUC management." (Id) To further suggest that only a small number of

individuals were behind the fraud, Silverman then added that "[w]e're outraged by the actions of

a small number of former CUC employees who betrayed the trust that was placed in them by the

Company and our fellow shareholders." (Id.)

277. The release did not disclose that the accounting irregularities resulted from

intentional fraud to meet earning expectations -- a fact well known to Cendant management since

at least April 9, 1998 (Report at 68-70). In addition, Cendant added in the press release that it

"remain[ed] committed to completion of the previously announced American Bankers, National

Parking Corporation and Providian Insurance transactions."

278. E&Y substantially participated in the making of the April 15, 1998 statement.)

First, E&Y had helped create the financial background of the statement -- three years of false

financial reporting -- upon which the $115 million maximum restatement estimate was based.

) Second, as revealed in Cendant's May 18, 1998 Form 8-K reporting E&Y's dismissal (discussed

below), E&Y was, until May 11, 1998, participating in the calculation of Cendant's restatement.

Third, if E&Y made an even perfunctory attempt to adhere to the requirements of GAAS and

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AU, § 561.06 (as more fully described herein), it must have consulted with Cendant on the form

and substance of the required notice to the public that its prior audit reports were false when

made.

279. Cendant's public relations strategy of burying the general disclaimer of its

financial statements, and mixing the misleading restatement information with cheerleading, was

successful. The New York Times article that was published on April 16, 1998 bore the headline

"Cendant Finds $115 Million Accounts Error." It reported that the restatement could be "as

much as $115 million," (emphasis added) and contained no mention of any possibility of a larger

figure, or any possibility that the irregularities could affect any year before 1997. There was no

mention of the Company's buried warning that its financial statements should not be relied upon.

(A printout of the New York Times' April 16, 1998 article by David Morrow is Exhibit G in the

accompanying Appendix.)

280. Articles in the Wall Street Journal, Dow Jones Online News, the Minneapolis

St. Paul Tribune, the Pittsburgh Post-Gazette, the Newark Star-Ledger, USA Today, the

Washington Post, the New York News Day, the New York Daily News, the Baltimore Sun, the

Los Angeles Times, The Bergen County Record, and the San Diego Union-Tribune, from April

) 15 through 17, 1998, all reported the restatement as being "as high as" or "as much as" $115

million, but not more, and affecting only 1997 (and perhaps 1998). None reported that the

Company's previous financial statements and audit reports should not be relied upon. (The

collected articles are Exhibit E in the Appendix.) As far as plaintiffs are aware, no major news

organization quoted, cited, or ever referred to Cendant's buried disclaimer that its previous

financial statements and auditor's reports should not be relied upon.

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11)

281. Only two days after the announcement, Cendant issued a joint press release on

April 17, 1998 with American Bankers to reaffirm their commitment to complete the merger

agreement between the two companies. In the release, Silverman stated:

With the normal regulatory process, we would expect the ABItransaction to be completed late summer, . . . By that time, we expectthe accounting issues to be behind us and, assuming our businesscontinues to perform strongly as it has to date, we would expect ourstock price to have recovered from current levels. We would like toremind investors that the price of our shares is not relevant with respectto the ABI transaction until 10 days prior to the closing.

We continue to be enthusiastic about our combination with AmericanBankers and look forward to taking advantage of the many opportunitiesit will create for both companies.

282. Through this release, Cendant continued the effort it had made in its April 15th

announcement, by suggesting that the "accounting issues" were relatively minor and would not

have a long term impact on the price of Cendant's common stock, and that the American Bankers

transaction would proceed as planned.

283. To further convince the market that Cendant's financial condition remained

14 strong, Cendant issued another press release that same day to announce that it had received

necessary waivers from The Chase Manhattan Bank so as to keep its bank facilities fully

available following the previous report of the need to restate prior financials. The press release

stated:

The waivers were technically necessary in light of Cendant's April 15announcement that, as a result of its expected restatement of pastearnings, it must prepare revised financial statements. Having nowreceived these waivers, Cendant's committed bank facilities remain fullyavailable for, among other purposes, the funding of the Company'spreviously announced acquisition of National Parking CorporationLimited,

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. . . .

Henry R. Silverman, President and Chief Executive Officer of Cendant,said: "While the requirement to obtain these waivers was largely aformality, we are nevertheless pleased to have received such promptsupport from our banking syndicate. Cendant remains a financiallystrong and liquid company and remains committed to completing all ofits pending transactions."

284. On April 20, 1998, Cendant issued yet another press release in an effort to

continue to calm the market, this time announcing that Michael H. Wargotz had been named its

executive vice president and chief financial officer of its Alliance Marketing Division, the

Division which Cendant had reported in its April 15 announcement had been the source of the

accounting irregularities. After touting the benefits Wargotz would purportedly bring to the

Alliance Marketing Division going forward, the press release quoted Silverman as stating: "The

Alliance Marketing business is healthy, strong and profitable. We look forward to giving

investors a better understanding of that business so that our April 15 announcement can be

understood within a fuller context."

285. A week later, on April 27, 1998, Walter Forbes and Silverman issued, in a joint

release, a letter to Cendant shareholders which assured them that all necessary steps were being

taken to respond to the previously announced accounting irregularities, but again emphasized

Cendant's continued strength and financial viability.

286. In the first paragraph of the letter, Silverman and Forbes stated that they did not

believe that "the potential accounting problems exist anywhere other than where they were first

discovered," thereby suggesting that the problems were no worse than the $115 million

restatement disclosed on April 15, 1998. (emphasis added) (The April 27, 1998 Press Release

containing the Letter to Stockholders is Exhibit H in the accompanying Appendix.) In fact, the

95

accounting "problems" were fraudulent financial entries, were not "potential," but real, and were

far worse than previously disclosed. Defendants were aware of these facts but nevertheless

caused and allowed this misleading statement to be made. E&Y substantially participated in the

making of this misleading statement by its prior accounting work for Cendant and its

participation in the calculation of Cendant's restatement amount and its advice to Cendant

regarding the preparation and making of disclosures relating thereto.

0 287. In an example of the market's reaction to this cleverly phrased reassurance, on

April 29, 1998, Merrill Lynch reversed their downgrade of Cendant securities of April 16, 1998,

and raised their opinion from "Neutral/Accumulate" to "Accumulate/Accumulate." In its analyst

report, under the heading "Fundamental Highlights," Merrill Lynch stated:

In a release on Monday, company indicated that it does not believe thepotential accounting problems "exist anywhere other than where theywere first disclosed."

(The Merrill Lynch Analyst Report on Cendant Corp., April 29, 1998, is Exhibit I in the

accompanying Appendix).

The April 27, 1998 Letter to Shareholders also stated, in part:

Cendant is strong, highly liquid, and extremely profitable. The vastmajority of Cendarit's operating businesses and earnings are unaffected[by the accounting irregularities].

We have reaffirmed our conunitment to completing all pendingacquisitions: American Bankers, National Parking Corporation andProvidian Insurance. In this connection, we are pleased to note thattoday we completed the National Parking Corporation acquisitionfollowing shareholder and European Community approvals for thattransaction.

288. To further emphasize that Cendant intended to rebuild the value of its common

stock, on the next day, April 28, 1998, Cendant issued another press release to announce the

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promotion of Samuel L. Katz to the position of Executive Vice President Strategic Development,

who would be responsible "for the development of shareholder value creation strategies." In

stressing the importance of his role, Cendant reemphasized its commitment to the American

Bankers merger, stating:

"Sam Katz has made tremendous contributions to Cendant and itspredecessor company, HFS Incorporated, which have greatly enhancedshareholder value," said Monaco, [to whom Katz would report.] "He hasa unique ability to identify strategic opportunities and to structure andexecute those which he believes will give Cendant a comparativeadvantage and an ability to create change in the marketplace."

Katz, 32, joined HFS as Senior Vice President-Acquisitions in January1996. Since then, he has been directly involved in all aspects ofCendant's corporate development through more than $22 billion ofannounced and pending strategic transactions, including the HFS-CUCmerger and the acquisitions of Caldwell Banker, Avis, RCI, PHH, TheHarpur Group Ltd, Jackson-Hewitt, Providian Insurance, AmericanBankers, National Parking Corporation (NPC) and Credential ServicesInternational (CSI). He also played an integral role in the formation ofNRT Incorporated, a joint venture between HFS and ApolloManagement, Inc.

289. As promised in the April 27 shareholder letter, Cendant issued a press release

on May 5, 1998 to report its first quarter results ended on March 31, 1998, announcing that the

Company had net income and revenue for the quarter of $229.5 million and $ L44 billion,

respectively. To continue its effort of downplaying the significance of the accounting

irregularities, Cendant stated:

More than eighty percent of the Company's net income for the firstquarter of 1998 came from Cendant business units not impacted by thepotential [CUC] accounting irregularities. Net income for thosebusinesses unaffected was $189.1 million for the first quarter 011998compared with $91.1 million for the same period in the prior year, anincrease of 108%. Revenue for those same businesses was $699.6million compared with $520.0 million for the same period in the prioryear, an increase of 35%.

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290. On May 15, 1998, Cendant filed with the SEC its quarterly report on Form 10-

Q for the quarter ending March 31, 1998, which repeated the financial results reported in the May

5, 1998 press release.

291. Although Cendant stated in its May 5 announcement that the first quarter

results were "preliminary" and could be affected by the Audit Committee's investigation of

accounting irregularities, later that day Cendant issued another press release to "clarify" the first

one, stating:

[Cendant's] 1998 first quarter results announced earlier were compiled inaccordance with what Cendant believes are appropriate accountingpractices, and reflect the elimination of any potential historicalaccounting irregularities under investigation by the Audit Committee ofCendant's Board of Directors.

In truth and in fact, Cendant's first quarter results were inflated by irregularities that later were

the subject of a restatement, as described below.

292. Two days later, on May 7, 1998, Cendant announced that it was extending its

cash tender offer to purchase approximately 23.5 million shares of American Bankers at a price

of $67 per share until July 1, 1998, subject to further extensions. Cendant reported that as of

May 6, 1998, 30,580,276 shares of American Bankers stock had been tendered.

293. The next day, on May 8, 1998, Cendant issued a further announcement to

continue its emphasis on the completion of the American Bankers merger, stating that it had

named John H. Carley to a newly created position of Senior Vice President, Legal and

Regulatory Affairs. With respect to his role, Cendant stated:

Mr. Carley will have responsibility for Cendant's relationship with allregulatory authorities relating to its businesses, including the severalstate insurance departments following Cendant's acquisitions of

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American Bankers Insurance Group and Providian Home and AutoInsurance, and assist in litigation matters.

294. On May 18, 1998, Cendant revealed in a press release and a Form 8-K that it

had terminated E&Y, effective May 11, 1998. Notably, the press release and Form 8-K indicated

the absence of disagreement between Cendant and its now former auditors, despite the fact that

the company's financial statements had been declared unreliable. The release revealed that E&Y

had continued to work for the Company after the April 15, 1998 announcement, apparently in

preparing the contemplated restatement, since the release said that Deloitte & Touche would be

taking over E&Y's duties in that area.

295. Cendant made the following statements in its Form 8-K and the incorporated

attachments:

(a) The reports of Ernst & Young, LLP on the financial statements forthe past two fiscal years of the Company contained no adverseopinion or disclaimer of option and were not qualified or modifiedas to uncertainty, audit scope or accounting principles.

(b) The Audit Committee of the Company's Board of Directorsparticipated in and approved the decision to dismiss Ernst &Young, LLP.

(c) In connection with its audit for the two most recent fiscal years andthrough May 11, 1998, there were no disagreements with Ernst &Young on any matter of accounting principles or practices,financial statements disclosure, or auditing scope and procedure,which disagreements if not resolved to the satisfaction of Ernst &Young LLP would have cause Ernst & Young LLP to makereference to in their report on the financial statements for such twoyears. . . .

(d) During the two most recent fiscal years and through May 11, 1998,there were no reportable events as that term is defined in Item304(a)(1)(v) of Regulation S-K. However, as part of itsannouncement of accounting irregularities, the Company has said

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that previously issued financial statements and auditor's reportsshould not be relied upon. (emphasis added)

296. A "reportable event" under Regulation S-K, which requires the disclosure of

such events upon the termination or resignation of an audit, is one of the following:

(a) The accountant's having advised the registrant that the internalcontrols necessary for the registrant to develop reliable financialstatements did not exist;

(b) The accountant's having advised the registrant that information hascome to the accountant's attention that has led it to no longer beable to rely on management's representations, or that has made itunwilling to be associated with the financial statements preparedby management;

(c) The accountant's having advised the registrant of the need toexpand the scope of its audit, or that information has come to theaccountant's attention during [the last two fiscal years and throughMay 11, 1998], that if further investigated may (i) materialityimpact the fairness or reliability of either: a previously issued auditreport or the underlying financial statements, or the financialstatements issued or to be issued covering the fiscal period(s)subsequent to the date of the most recent financial statementscovered by an audit report.. . or (ii) cause it to be unwilling to relyon management's representations or be associated with theregistrant's financial statements, and (2) due to the accountant'sresignation . . . or dismissal, or for any other reason the accountantdid not so expand the scope of its audit or conduct such furtherinvestigation; or

(d) (1) The accountant's having advised the registrant thatinformation has come to the accountant's attention that it hasconcluded materially impacts the fairness or reliability of either (i)a previously issued audit report or the underlying financialstatements, or (ii) the financial statements issue or to be issuedcovering the fiscal period(s) subsequent to the date of the mostrecent financial statements covered by an audit report . . . and (2)due to the accountant's resignation, dismissal or declination tostand for re-election, or for any other reason, the issue has not beenresolved to the accountant's satisfaction prior to its resignation.dismissal or declination to stand for re-election.

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C

Thus, by stating that there were no "reportable events," Cendant falsely represented that the

events (a) through (d) above did not occur.

297. With its Form 8-K, Cendant filed a letter from E&Y stating that it had

reviewed the above representations and agreed with the statements quoted in the preceding

paragraph. By that agreement, E&Y also falsely represented that these events did not occur, and

effectively admitted that it took virtually no steps, at any time, to cause the correction of the

irregularities detailed in the Report. (Cendant's May 18, 1998 Form 8-K is Exhibit J in the

accompanying Appendix.)

298. Cendant issued another press release on May 29, 1998, concerning an increase

of its credit facilities, stating:

[Cendant] has entered into a new $3.25 billion term loan credit facilitywith The Chase Manhattan Bank and a syndicate of 20 other lendersincluding Bank of America, Barclays Capital, Bank of Nova Scotia,Credit Lyonnais, and Nations Bank. Due to a very strong reception bythe banking syndicate, the Company increased the facility to $3.25billion from the $2.0 billion commitment previously announced. Theloan is payable on May 28, 1999.

According to the Company's Vice Chairman and Chief Financial Officer,Michael P. Monaco, completion of this transaction provides Cendantwith a combination of cash and committed undrawn revolving creditfacilities significantly in excess of the amount of cash necessary to closethe previously announced pending acquisitions of RAC MotoringServices, Providian Auto and American Bankers.

"We are delighted with the overwhelming support the banking syndicatehas shown the Company," Monaco said. "This extraordinarily successfulsyndication reflects the Company's strong capital base and access toliquidity through varied sources. It further demonstrates the Company'ssignificant credit ratios and our ability to generate capital for strategicacquisitions and other purposes."

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;-1

299. On July 2, 1998, Cendant issued a press release again extending its cash tender

offer to acquire the American Bankers stock. By this time, 32,762,383 shares of American

Bankers stock had been tendered.

B. THE TRUTHFUL REVELATION OF THE FRAUD

300. Throughout the Class Period, Cendant, the Individual Defendants and E&Y

had led the market to believe that Cendant's bad times were behind it, that investors could

reasonably expect the price of the Common stock to rebound, and that the "potential accounting

problems" were no worse than previously announced, and perhaps not the result of fraud.

Cendant also represented that it was moving forward toward completion of the American

Bankers merger and other transactions.

301. In sharp contrast to these representations, Cendant shocked the market on July

14, 1998, by announcing that the accounting irregularities were far more pervasive than had

previously been reported, and had resulted in an overstatement of net income that was more than

double the amount announced on April 15, 1998, L e. over $200 million. Furthermore, Cendant

disclosed that it would need to restate its financial reports for the prior three years, from 1995

through 1997, rather than just for a single year. And for the first time, Cendant disclosed that

these formerly "potential accounting problems" were the result of intentional fraud.

302. In comparison to the estimated restatement of between 11 and 13 cents per

share, reported in the April 15 announcement, Cendant disclosed on July 14 that it now believed

its restatement would lower 1997 net income alone by 22 to 28 cents per share. Moreover, it

reported that it expected its 1998 earnings per share from continuing operations to be five to six

cents lower than previously expected. According to Monaco, as quoted in the release:

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"[I)n the course of our in-depth review of these businesses, we haverevised and refined our historical database of cancellation and charge-back experience. In this business, revenues and earnings frommembership assets are accrued using accounting grids that calculate ourfinancial benefit over time while incorporating appropriate inputs forcancellations and other sources of attrition. Refinements in theseassumptions in connection with the investigation changed our forecastfor 1998."

303. The reaction of the market to this full disclosure actually began on July 13,

1998, with heavy trading (of double Cendant's average daily volume), amid rumors that the

accounting irregularities were far worse than previously reported. (See Dow Jones News

Service, July 13, 1998, Exhibit K in the accompanying Appendix.) On that day, Cendant's

common stock fell by $3.125, or 14% of its opening price of $22. The following day, after the

announcement, both the Cendant common stock and the PRIDES declined further in value, with

the Income Prides falling from the previous day's close of $34-3132 to $30-114 and the Growth

PRIDES following from $29-3/8 to $25. Class members who acquired PRIDES during the Class

Period suffered extensive damages as a result. Common stock also declined 17% in value.

304. This reduction in price reveals that the defendants had in fact succeeded in

concealing the fraud from the market and in preventing the dissipation of the effects of the fraud

on the price of Cendant securities. Over the two day period that the complete story became

known and incorporated into the market price of Cendant securities, Cendant common stock

declined from $22 to $15 11116, a decline of approximately 29%. Obviously, the information

leaked on July 13, 1998 and disclosed on July 14, 1998 was new to the market, although not to

the defendants.

305. The reaction of the media also demonstrates that, until July 14, 1998, the full

extent of the fraud had been successfully concealed. For the first time, the investing public

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learned that the previously disclosed "potential accounting problems," as they were described by

Silverman and Forbes in their April 27, 1998 letter to shareholders, were actually "widespread

and systematic . . . accounting errors made with an intent to deceive," including "fictitious

revenues." ("Cendant Stock Tumbles Again After 2' Jolt," Baltimore Sun, July 15, 1998, at

1C.) The Wall Street Journal reported that the fraud was "far deeper than originally thought."

(The Wall Street Journal, July 15, 1998, at A3.)

306. Further evidence that this disclosure was much more than confirmatory is

found in analyst's reports. After upgrading Cendant to "Accumulate/Accumulate" on the basis of

Silverman's reassurances, in the wake of the July 14, 1998 announcement Merrill Lynch

downgraded Cendant to "Neutral/Neutral" on July 16, 1998 and removed Cendant PRIDES from

their Convertible Model Portfolio on July 15, 1998. (The Merrill Lynch analyst reports of July

) 15, 1998 and July 16, 1998 are Exhibit L in the accompanying Appendix.)

307. In an announcement on October 13, 1998, Cendant announced in a press

release that the merger agreement with American Bankers had finally been terminated by

)"mutual decision." Significantly, Cendant reported that, pursuant to the merger agreement, it had

to make a $400 million cash payment to American Bankers as a condition of the termination.

(Press Release Oct. 13, 1998.) To reflect this payment, Cendant would have to take a $280)

million after-tax charge in the fourth quarter.

308. After recklessly touting the importance of the American Bankers merger, and

Cendant's ability to complete it notwithstanding the accounting irregularities, this announcement

proved the futility of Cendant's effort -- a fact which the Exchange Act Defendants knew or

recklessly ignored.

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VIII. ERNST & YOUNG'S KNOWLEDGE OF THE FRAUD

309. The audit reports that E&Y prepared, and caused and allowed to be filed with

the SEC on January 29, 1998, February 23, 1998 and March 31, 1998, were materially false and

misleading because, inter alia, E&Y did not conduct its audits of the CUC and CMS financial

statements and balance sheets in accordance with GAAS and because, as detailed above, the

financial statements and balance sheets did not present fairly, in conformance with GAAP, the

financial condition and results of operations of CUC, CMS and Cendant.

310. GAAS are the professional standards applicable to accountants engaged in

auditing financial statements. GAAS are established principally by the Auditing Standards

Board of the AICPA, which promulgates Statements on Auditing Standards ("SAS"). SASs are

official interpretations of the ten generally accepted auditing standards and must be adhered to in

an audit of financial statements. SASs are codified in the AICPA's Codification of Statements

on Auditing Standards ("Codification"), which contains sections with the prefix "AU." In

addition, GAAS, specifically SAS No. 71 (Interim Financial Information), AU § 722, establishes

certain authoritative requirements when accountants perform reviews of quarterly financial

information.

311. E&Y specifically represented in its audit reports that each of its audits of CUC

and CMS were conducted in accordance with GAAS. In fact, none of its audits, for the CUC

fiscal years ending January 31, 1996 or January 31, 1997, or for CMS for the year ending

December 31, 1997, were conducted in accordance with GAAS. Therefore, E&Y's

representations were false.

A. ERNST & YOUNG'S SCIENTER

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312. The departures from GAAS detailed herein support a strong inference that

Ernst & Young knew of, or at best was willfully blind to, the falsity of its representations that it

conducted its audits in accordance with GAAS and that Cendant's, CUC's and CMS's financial

statements and balance sheets fairly presented the financial condition and results of operations of

those companies in accordance with GAAP. E&Y's disregard of GAAS was an extreme

departure from the standards of ordinary care common to auditors, presenting an obvious danger

of misleading investors, that was known to E&Y or is so obvious that the inference that it knew

of the danger is inescapable.

313. As detailed herein, and in the Report and Cendant's Complaint, on several

occasions E&Y possessed information sufficient to inform it that at least some part of CUC's

financial reporting was false. Yet, time and again, E&Y failed to report any such problem or

take any action whatsoever. In addition, the absence of internal controls at CUC were obvious,

yet E&Y failed to report them as required by GAAS. And, as shown below, when E&Y failed to

request information, such as the quarterly reporting packages it requested for every operating unit0

of CUC except Comp-U-Card, it did so in a suspicious manner indicative of a desire not to be

charged with knowledge of a fraud that it knew or suspected was ongoing.

314. Further support for an inference of scienter is provided by the close

relationship between E&Y and its former employees at CUC, many of whom were directly

implicated by the Audit Report in making the topside adjustments and improper merger reserve

allocations that are the heart of the fraud. Indeed, as the Report shows, those employees showed

a distinct desire that irregular accounts be audited by E&Y, rather than Cendant's new auditors,

Deloitte & Touche: When Shelton told Scott Forbes about his "creative ideas" for using merger

106

reserves to inflate income, he requested that E&Y continue its audit of the Comp-U-Card

division since that "division was where most of the reserve reversals were scheduled." (Report at

42, 58.) To the extent that CUC executives appeared to take steps to conceal their conduct from

E&Y, that is easily explained by a desire to avoid embarrassing E&Y or destroying its ability to

plausibly deny knowledge of the massive fraud that was going on right under its nose.

315. Rather than adhering to the dictates of GAAS, E&Y deliberately turned a blind

eye to any potential fraud, reminiscent of Sergeant Schultz of Hoga.n's Heroes fame ("1 see

nothing. . nothing."). This deliberate indifference to red flags is proscribed by the securities

laws and easily satisfies the level of scienter required for liability under the Private Securities

Litigation Reform Act. Taken together, all the facts and circumstances described in the Report

and the Cendant Complaint provide a more than sufficient basis for the strong inference of

3 scienter required for liability under Section 10(b) and Rule 10b-5.

B. FAILURE TO NOTE IMPROPER RECOGNITIONOF MEMBERSHIP REVENUE

316. E&Y had notice of certain red flags concerning substantial understatement of

Comp-U-Card's membership reserve in 1995, 1996, and 1997. (Report at 223.) One means

utilized by CUC officials to accomplish this portion of the fraud related to the posting of billings

to a member's credit card which had been rejected by the relevant financial institutions. (Id. at

215.) As the Report concluded, "[b]asic accounting procedures would indicate that reconciling

items in a bank reconciliation (such as rejects in transit) should be journalized and recorded in

the general ledger each month as they are reported by the bank." (Id. at 217).

107

317. CUC, however, had a practice, predating 1995, of not writing off any rejects to

the membership reserve for the last three months of each year. (Id.) Instead, CUC "would

'hold' three months of rejects at year-end and book them in the first quarter of the next year."

(Id.) In early November 1997, in anticipation of an "early audit sign off' by E&Y due to the

merger of HFS and CUC officials then decided to depart from the practice of holding three

months of rejects at year end and instead decided to "record rejects on a constant three-month

lag." (Id)

318, According to the Report and as detailed above, E&Y knew about the three

month delay in posting rejects. (Id. at 231-32; emphasis added.) Thus, despite CUC's history of!.)

overly aggressive accounting of costs, and the known fact that CUC was improperly delaying the

booking of rejects for three months, E&Y did not question the recognition of membership

revenue that it knew included members whose credit cards had been rejected.

C. SPECIFIC KNOWLEDGE OF THE CNA CONTRACT FRAUD

319. According to Cendant's Complaint and the Report, during E&Y's audit of

CMS's consolidated financial statements for calendar year 1997, E&Y obtained evidence of a

GAAP violation when it reviewed a $30 million charge to the Cendant merger reserve in

connection with the payment of that amount to CNA on December 1997. Whereas charging the

$30 million payment to the Cendant merger reserve might have been proper if the CNA contract

had been terminated as a result of the merger, use of the Cendant merger reserve was clearly

improper if the CNA contract was merely being renewed or renegotiated.

108

320. According to Cendant's Complaint and the Report, E&Y was provided a

signed copy of a letter stating that the CNA contract was being renewed. (Report at 171 and 173

n. 155; Cendant Complaint, 107.) That letter was initialed by Rabinowitz, the partner-in-

charge of the audit. (Id.) Yet E&Y did not question the improper $30 million payment to the

Cendant merger reserve, the effect of which was to artificially inflate CMS's future income,

El. KNOWLEDGE OF THE $170 MILLION COMP-U-CARD DISCREPANCY

321. Likewise, according to Cendant's Complaint and the Report, in preparation for

the merger with HFS, E&Y obtained Comp-U-Card's trial balance as of September 30, 1997, as

well as the consolidating report for that period of time. According to Cendant's Complaint, '11

108, and the Report, at 109 n. 111, there was an approximately $170 million difference between

(i) the revenue amounts stated on Comp-U-Card's trial balance through September 30, 1997 and

3 (ii) the revenue amounts stated on the topside-adjusted consolidating report for the same period.

Although evidence of this huge discrepancy was in its hands, E&Y never reported it to CUC's

top management or audit committee, as required by Codification, AU §§ 325, 380 and 722.

E. WILLFUL IGNORANCE OF THE COMP-U-CARDQUARTERLY REPORTING PACKAGES

322. According to the Report and Cendant's Complaint, E&Y failed to request the

quarterly reporting packages for Comp-U-Card, CUC's and later CMS's largest revenue

generator, in conducting its reviews of CUC's quarterly financial statements. (Report at 78:

Cendant Complaint, 110.) In fact, those were the only quarterly reporting packages not

reviewed by E&Y during their quarterly reviews in 1997. (Report at 78; Cendant Complaint, 'II

110.) Had E&Y reviewed those quarterly reporting packages for Comp-U-Card, it would have

109

immediately noted the absence of the top-side adjustments that CUC management had placed on

the quarterly financial statements (which were covered by improper revenue from merger

reserves at year-end). (Cendant Complaint, 110.) Although the Report indicates that CUC

management intentionally failed to send the quarterly packages for Comp-U-Card to E&Y, only

willful blindness or knowing complicity could explain E&Y's failure to note their unique

absence and demand their delivery.

F. KNOWLEDGE OF INFLATION OF INCOME

323. E&Y also had notice of certain inflation of income. For example, for the

month of January 1997, CUC had income of $66 million, "an amount substantially higher thana

the income for an average month in 1997." (Report at 55.) This observation was specifically

communicated to E&Y partner Rabinowitz. (Report at 55-56). E&Y was unable "to confirm the

) reasonableness" of a substantial part of the net income figure for this month, totaling in the "high

20's of millions of dollars," but nevertheless reported to Cendant's Audit Committee on February

3, 1998 that the overstatement was not material. (Report at 55, 56 n.55.) Hut for E&Y's

)complicity or willful blindness, it would have realized that the overstatement was due to

accounting irregularities inconsistent with GAAP.

) G. KNOWLEDGE OF MISMATCHING OF REVENUE AND EXPENSES

324. E&Y also had knowledge of the mismatching of revenues and expenses at

Comp-U-Card—the immediate recognizing of revenues but deferral of expenses. Although

)CUC's stated policy was to recognize all membership fees ratably over the membership period,

in practice there were some programs, such as Privacy Guard and Dining, where Comp-U-Card

recognized all the revenues on an immediate basis at the time the member joined.

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'

Approximately 21% of Comp-U-Card's total membership revenues in 1997 were derived from

such immediate recognition programs. (Report at 200.) E&Y partner Rabinowitz knew about

this policy with respect to certain Comp-U-Card programs. (Id At 204-05.) Yet, E&Y did

nothing to correct this mismatching of revenue and expenses.

E&Y'S KNOWLEDGE OF IMPROPER MERGER RESERVES

325. In connection with its audit of CMS's 1997 consolidated financial statements,

Cendant's Complaint reports that E&Y was not provided, nor did it ever request from CMS, the

hundreds of inappropriate and unsupported non-recurring, post-closing journal entries. (Cendant

Complaint, 110.) Also according to Cendant's Complaint, E&Y did not even review the post-

)closing journal entries. (Id) These journal entries were used, among other things, to reverse

approximately $55 million of merger reserves into income for CUC for calendar year 1997. Had

E&Y audited those post-closing journal entries, or even just a sampling of them, together with

supporting detail (as required by GAAS), for CUC in Fiscal Year 1996 and 1997 and for CMS

for 1997, it would have discovered the improper use of merger reserves under GAAP that

pervaded the financial statements of CUC and then of CMS and Cendant. (Id)

326. E&Y also had ample red flags that should have caused it to suspect the

improper use of merger reserves. The Ideon Reserve was created by CUC by taking a special

charge of $179.9 million in early 1997 for the year ended January 31, 1997, for certain merger,

integration and litigation costs, with $70 to $90 million reserved for litigation costs. (Report at

38-39, 41.) During its audit of the December 31, 1997 financial statements of CMS. E&Y was

informed that only $18 million of litigation expenses had been charged to the Ideon Reserve but

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that CUC had experienced greater than expected merger integration costs and therefore it had

reallocated the merger reserves for this purpose. (Id. at 41).

327. During its audit of CMS' financials for December 31, 1997, E&Y knew that by

the end of 1997. CUC had essentially utilized the entire $179.9 million Ideon Reserve created0

only eleven months before. As the Report stated, "E&Y had not obtained documentary support"

for at least $25 million of this utilization. (Report at 65.) It, nevertheless, accepted Corigliano's

vague explanation of increased "integration costs," and concluded that this amount was not

material. (Id.). No reasonable accountant could have concluded, given the utilization of the

entire $180 million merger reserve, that the absence of support for $25 million of it was not

material.

I. FAILURE TO REPORT INTERNAL CONTROL DEFICIENCIES

328. As defined under SAS No. 60, CUC and Cendant had severe, widespread and

material internal control weaknesses. Such control weaknesses are required to be reported to the

Company's audit committee under auditing standards promulgated by the AICPA under

Statement on Auditing Standard ("SAS") No. 78, "Consideration of Internal Control in a

Financial Statement Audit." (detailed above.)

329. E&Y substantially departed from GAAS by either not detecting or not

reporting to CUC's and Cendant's audit committees material internal control weaknesses as

required by SAS Nos. 55, 60 and 78. (detailed above.) (See also AU §§ 319.04:05, 325,

380.06)

330. As detailed above, in the Report and in the Additional Conclusions, the Audit

Committee has recognized basic internal control weaknesses at Cendant. (Report at 73 n.74 &

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Additional Conclusions.) In addition, Cendant has admitted the existence of all the Internet

control deficiencies noted in the Report. (Cendant Complaint, 121.)

331. According to Cendant's Complaint, E&Y did not report the internal control

deficiencies that should have been obvious to it. Indeed, E&Y specifically reported to the Audit

Committee, after the completion of its audits for the Fiscal Years 1994, 1995, 1996, and 1997,

and of CMS for the calendar 1997, that it observed "no matters involving the internal control

0 structure and its operations that [it] consider[ed] to be material weaknesses." (Cendant

Complaint, if 122.) E&Y could not have been ignorant of these internal control deficiencies.

Rather, it either recklessly failed to recognize them as such, or, more likely, intentionally

declined to report them as required by GAAS.

J. FAILURE TO MAINTAIN PROFESSIONAL SKEPTICISM

332. Nor were E&Y's audits conducted with the attitude of "professional

skepticism" required by Codification, AU §§ 312, 230, 316 and SAS No. 53 (superseded by AU

§ 316 as of December 15, 1997). AU § 230.07 states: "Professional skepticism is an attitude

that includes a questioning mind and a critical assessment of audit evidence. The auditor used

the knowledge, skill, and ability called for by the profession of public accounting to diligently

perform, in good faith and with integrity, the gathering and objective evaluation of evidence."

333. According to Ceridant's Complaint, E&Y allowed the representations of the

financial reporting and accounting personnel of CUC and then CMS to "substitute for the

application of those auditing procedures necessary to afford a reasonable basis for [its] opinion

on the financial statements," thereby "violating" the explicit terms of Codification, AU §

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333A.02. (Cendant Complaint, 111.) As Cendant has stated, E&Y engaged in "auditing by

conversation" instead of "auditing through evidence." (Id)

334. E&Y's failure to corroborate the representations of CUC's and CMS's

financial reporting personnel, as required by AU § 333A, allowed it to maintain (in its own view)

plausible deniability, thereby permitting it to claim that it was ignorant of the improper use of the

merger reserves. Indeed, the Report cites numerous instances when certain expenses were

improperly written off against merger reserves because E&Y failed to confirm unsupported

representations by CUC or CMS financial reporting personnel.

335. For example, according to the Report, during E&Y's audit of CMS's 1997

consolidated financial statements, E&Y was informed that approximately $2.3 million was being

written off against the Cendant merger reserve because the development of a planned computer

system was never implemented, when, in fact, one of CMS's subsidiaries had not only developed

the computer system and was actually using it. (Report at 182-83; Cendant Complaint, If 113.)

A simple telephone call to the head of MIS at the subsidiary to attempt to corroborate the oral

representation would have revealed the irregularity. (Cendant Complaint, 113.)

336, In addition, during E&Y's audit of CMS's 1997 consolidated financial

statements, E&Y was informed that approximately $3.75 million of goodwill was being written

off against the Cendant merger reserve because, as a result of the merger, a subsidiary of CMS

had decided to discontinue a program of providing credit card services to American Express

customers. (Report at 189-90; Cendant Complaint, 114.) In fact, American express had

terminated the subsidiary's program, for reasons wholly unrelated to the merger. (Cendant

Complaint, 114.) Had E&Y enquired about the reason for termination of the program, it would

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have discovered the misrepresentation and discovered the impropriety of writing off that portion

of Cendant's merger reserve. (Id.)

K. FAILURE TO MAINTAIN INDEPENDENCE

337. E&Y placed undue reliance on CUC executives because, as already stated,

several top CUC officials, including certain key players complicity in the accounting fraud, were

former E&Y employees. They included Corigliano, Kearney, Pember, and Sattler. (Report at

26.) According to Cendant, E&Y Partner Rabinowitz was a close "personal friend" of Cosmo

Corigliano, the highest ranking CUC officer directly charged with wrongdoing by the Report.

(Cendant Complaint, .7 16.) Indeed, CUC officials were so at ease with successfully continuing

)their fraud with E&Y as their supposed watch dog that on March 5, 1998, when Shelton was

telling Scott Forbes about his creative ideas for using merger reserves to inflate income, he

requested that E&Y continue its audit of Comp-U-Card division since that "division was where)

most of the reserve reversals were scheduled." ( Id. at 42, 58.)

L. E&Y's COMPLICITY IN THE MISLEADINGAPRIL 15, 1998 PRESS RELEASE

338. In February 1997, the American Institute of Certified Public Accountants

(AICPA) issued a new standard in the area of fraudulent financial reporting. Statement on

) Auditing Standards No. 82, "Consideration of Fraud in a Financial Statement Audit" (SAS 82),

which is effective for periods ending on or after December 15, 1997 (in the case of CUC/CMS,

SAS 82 applies to calendar 1997).)

339. Prior to SAS 82, the relevant standard was contained in Statement on Auditing

Standards No. 53, "The Auditor's Responsibility to Detect and Report Errors and Irregularities"

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.7)

(SAS 53), which had been effective for periods beginning on or after January 1, 1989 (in the case

of CUC, SAS 53 applies to fiscal 1996 and fiscal 1997). (See also SAS No. 54 (April 1988), Ali

§ 317 ("Illegal Acts by Clients.") (detailed above)). The controlling GAAS standard for

examination and reporting of irregularities prior to fiscal 1997 is SAS No. 53, entitled "THE

AUDITORS RESPONSIBILITY TO DETECT AND REPORT ERRORS AND

IRREGULARITIES." (detailed above.)

340. In addition, under the Exchange Act, § 10A, the auditor must attempt to detect

fraud, and, under certain circumstances, report it. Section 10A of the Securities Exchange Act,

entitled "AUDIT REQUIREMENTS," essentially codifies SASs 53 and 54. 15 U.S.C. § 78j-1.

As detailed above, E&Y utterly failed to conduct its audits in conformance with SAS Nos. 82, 53

and 54, or Section 10A of the Exchange Act.

341. Indeed, E&Y has since shown total disregard for its obligations under GAAS

and Section 10A by averring in its brief in this Court in support of its motion to dismiss the

Common Stock Complaint, that "generally accepted auditing standards do not require them to

employ procedures designed to detect fraud." (Defendant Ernst & Young LLP's Memorandum

in Support of Its Motion to Dismiss the Common Stock Complaint, March 5, 1999, at 20.)

342. As stated in SAS No. 54, one instance when discovered illegalities should be

disclosed by an auditor is when the auditor is terminated or resigns. SEC Regulation S-K

requires that a report by an auditor to a registrant of illegalities that materially affect the validity

of previously issued financial statements that are the subject of an auditor's report is a

"reportable event," even if there was no disagreement between the auditor and the registrant on

that subject. Regulation S-K, Item 304(a)(1)(v). The accountant is required to correct any

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failure to disclose a "reportable event" by the registrant. (Id, Item 304(a)(1)(v)(D)(3).) In

addition, if adequate corrective action is not taken by the Company after an auditor reports illegal

acts to the Board, Section 10A(b)(3) requires the auditor to make a report of the illegal acts to the

SEC. Securities Exchange Act, § 10A(b)(3); 15 U.S.C. § 78j-1(b)(3).

343. In addition, SAS No. 1, § 561, requires the disclosure of illegal acts, or any

newly discovered information, that materially effects previously issued financial statements such

that an auditor's prior opinion on those statements is now known to be incorrect. Codification,

AU § 561.06, requires the auditor to ensure that the client takes appropriate steps to correct any

fraud. The Codification notes that the appropriate "method used and the disclosure made will

depend upon the circumstances." If, upon making appropriate demands, the client refuses to take

steps that the auditor considers adequate to prevent fraud, the auditor should notify regulatory

agencies and persons known to be relying upon the auditors prior auditor reports that those

reports should no longer be relied upon. AU § 561.08.

344. E&Y will no doubt point to Cendant's buried disclaimer of April 15, 1998,

purportedly made pursuant to SAS No. 1, that "the Company's previously issued financial

statements and auditors' reports should not be relied upon!' But that disclaimer was

accompanied by a misleading, incomplete disclosure that grossly understated the financial impact

of the fraud. It also referred to confirmed financial fraud as merely "potential accounting

irregularities" and the disclaimer was buried at the end of a three-page press release. In light of

those infirmities, the disclaimer cannot not satisfy E&Y's duty under AU § 561.06 to see that

fraud is disclosed. As AU § 561.06 states, the auditor must ensure that the client "undertakes to

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make appropriate disclosure," and "the method used and the disclosure made will depend upon

the circumstances."

345. Under all the circumstances, the disclosure made on April 15, 1998 was

inappropriate and insufficient. E&Y failed to "take whatever steps [it] deems necessary to satisfy

[it]self that the client has made the disclosure" and defaulted on its duty to "take steps to prevent

future reliance on its report." (AU § 561.07 and .08.)

346. The facts support a strong inference that E&Y knew on April 15, 1998 that

Cendant's disclosure of a restatement of at most $115 million was a gross misrepresentation of

the scope and impact of the fraud, and that the descriptions of "potential" accounting

irregularities was a gross understatement of the true circumstances. With that knowledge, E&Y

cannot maintain that Cendant's buried "SAS No. 1" disclaimer satisfied its duties under GAAS,

or insulates it from liability for Cendant's prior false financial statements and its false auditor's

reports.

347. Defendant Ernst & Young, because it was assisting Cendant with the

preparation of a complete restatement, participated in and caused and allowed Cendant to make

these false representations. Ernst & Young had a duty pursuant to Statement of Auditing

Standards No. 1. to ensure that its previously issued audit reports, which it now knew should not

be relied upon, were not further relied upon by the investing public. E&Y surely conferred with

Cendant, pursuant to AU § 561.06, on its April 5, 1998 press release that buried the SAS No. 1

warning after 2 1/2 pages of misleading and distracting information. It was also surely aware that

the warning was not reported by the press. Despite the extreme and obvious risk that the market

was being misled, E&Y took no steps to correct Cendant's misleading representations.

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348. Despite Cendant's partial, incomplete and misleading statement on April 15,

1998 and thereafter, E&Y took no action at any time to reveal the full extent and scope of the

fraud. Indeed, to plaintiffs knowledge, the only public statement E&Y has ever made about this

matter was to the New York Times as reported in an article on April 17, 1998:

Asked for comment yesterday, Patricia Ingrassia, a spokeswoman forErnst & Young, said, "Nothing has been brought to our attention tosuggest that our work was not in accordance with professionalstandards."

(Floyd Norris, "Cendant's Share Price Plunges 46% on "Accounting Irregulatories," New York

Times, April 17, 1998, at 1D, Col. 2.) Had E&Y been as diligent in protecting the integrity of

CUC's financial statements as it is about protecting itself, this fraud would never have occurred.

IX. SCIENTER OF CENDANT AND THE INDIVIDUAL DEFENDANTS

349. Defendant Cendant ultimately admitted that the irregularities in its financial

statements were the result of intentional fraud by the highest levels of CUC management. The

Company's August 27, 1998 press release described the findings of the Audit Committee in no

uncertain terms:

The Audit Committee's report focused solely on accounting irregularities-- i.e., fraudulent financial reporting -- and chronicled in detail, throughnumerous examples, how CUC's income, excluding merger-related and

) unusual charges, was inflated by an aggregate of approximately $500million before taxes during the period 1995-1997. The report said thiswas accomplished through a wide range of irregular accounting entriesdirected by CUC corporate executives at its Stamford, Connecticutheadquarters and imposed upon personnel throughout the company in anescalating attempt to ensure that CUC's earnings would match analystexpectations.

The report found that more than one-third of total income, excludingmerger-related and unusual charges, reported by CUC during theRestatement Period was deliberately and fictitiously manufactured.

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350. Cendant's own words leave little room for doubt that the false statements

t) complained of here were willful and deliberate, at a level of management that does not allow

Cendant to escape responsibility for these actions.

351. in addition, the Audit Committee reported that many of the fraudulent

accounting entries were made at the direction of Corigliano, the Chief Financial Officer of CUC,

as well as CUC's Controller, Anne Pember. (Report, at 14.) The committee also reported that

the following CUC executives participated in the fraudulent scheme: the Vice President of

Accounting and Financial Reporting, the Director of Financial Reporting, the Controller of the

Comp-U-Card division, and CUC's Supervisor of Financial Reporting. (Report, at 15.)

352. In addition, Cendant's Audit Committee specifically held Cendant's Chief

Executive Officer, Walter Forbes, and Chief Operating Officer, Shelton, responsible for the

misstatements in CUC's financial reports, stating:

The Report prepared for the Committee by Wilkie Farr &Gallagher and Arthur Andersen LLP has reviewed much of the evidenceobtained with respect to whether or not members of senior managementof the former CUC International, Inc. ("CUC") including Walter Forbes,Chairman of the Board and Chief Executive Officer, and Kirk Shelton,President and Chief Operating Officer, had or may have had knowledgeof the irregularities detailed in the Report.

It is the view of the Committee that certain additional conclusionsbased on the work of the Committee and its professionals should bereported to the full Board. First, Walter Forbes and Kirk Shelton,because of their positions, had responsibility to create an environment inwhich it was clear to all employees at all levels that inaccurate financial

) reporting would not be tolerated. The fact that there is evidence thatmany of the senior accounting and financial personnel participated inirregular activities and that personnel at many of the business unitsacquiesced in practices which they believed were questionable suggeststhat an appropriate environment to ensure accurate financial reporting did

3 not exist. Second, senior management failed to have in place appropriate

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controls and procedures that might have enabled them to detect theirregularities in the absence of actual knowledge of those irregularities.Third, Walter Forbes and Kirk Shelton, the Company's most seniormanagers, had a responsibility to fully understand the sources and thetrue level of CUC's profitability. To the extent that they were unawareof the irregularities, the amount by which CUC's earnings were inflatedas reported in the Restatement suggests that they did not adequatelyinform themselves as to the sources and level of profitability of theCompany. For these reasons at least, Walter Forbes and Kirk Shelton areamong those who must bear responsibility for what occurred at CUC.

(Additional Conclusions of the Audit Committee, SEC Form 8-K, filed August 28, 1998, at 4.)

In effect, the Cendant Audit Committee has expressly concluded that Walter Forbes and Shelton

were knowing or reckless in their failure "to fully understand the sources and the true level of

) CUC's profitability," and, as such, are responsible for the financial misstatements.

353. Because the CUC individual defendants either participated directly in the

preparation of the false and misleading financial statements, or recklessly disregarded and were)

willfully ignorant of red flags that should have prompted them to prevent the issuance of false

financial information, the CUC individual defendants are liable for the issuance of false financial

information under Section 10(b) and Rule 10b-5.

354. As previously detailed, more than one-third of CUC's total reported operating

income during the period of 1995 through 1997 was "improperly inflated," "touching] the large)

majority of the company." (Report at 9.) Indeed, the accounting irregularities were "pervasive."

(Id.) The topside adjustments, in particular, which totaled nearly $200 million and were only

) made to the Cornp-U-Card division, could easily have been detected by any of the CUC

individual defendants had they undertaken their due diligence responsibilities in a serious

manner. The actual unadjusted results for this subsidiary were reflected in very basic and)

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accessible documents such as Comp-U-Card's quarterly budgets, its general ledger, and other

periodic reports—documents readily available to each of the CUC individual defendants.

355. The CUC individual defendants also knew that E&Y had a particularly close

relationship with the financial management at CUC that may have compromised its0

independence. As detailed herein, many of CUC's management personnel who played key roles

in the falsification of the financial statements—including defendant CFO Corigliano, Controller

Pember, as well as senior officers Kearney and Sattler—were former E&Y employees, and E&Y

realized significant fees from its relationship with CUC. As such, the CUC individual

defendants were not justified in blindly relying on E&Y' s audits without completing their own

due diligence to confirm the validity of the financial statements.

356. Because the Registration Statement and Prospectus contained unaudited

) financial statements for 1997, the CUC individual defendants also could not rely on any auditors

with respect to this data, but had to conduct their own due diligence to assure themselves that the

financial statements were correct, which they failed to do.

357. Moreover, questions should have been raised in the minds of the CUC

individual defendants due to the fact that CUC met analysts' expectations with a high degree of

) precision for virtually every quarter from 1995 through the Merger. Such precision warranted

further inquiry.

358. Finally, the CUC individual defendants should have been on notice of the need)

to be particularly careful about potential accounting irregularities at CUC as a result of its

history. In 1989, CUC was criticized by investors for spreading out the cost of recruiting new

)

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)

members over three years instead of reflecting those costs right away. As a result, CUC had to

restate its earnings that year, and took a S51.4 million charge to better reflect membership-

acquisition costs when it changed to a one-year schedule for amortizing recruitment costs. At the

time, Walter Forbes said that "it became clear that the market wanted the more conservative

policy." Then, in 1991, the SEC questioned the completeness of CUC's financial documents and

required numerous amendments to them. In light of this history, the need for careful due

diligence was heightened.

A. CENDANT DIRECTORS WHO WERE FORMER CUCINSIDERS AND CFO CORIGLIANO

)

359. The Cendant directors who had previously served as inside directors or officers

of CUC -- defendants Walter Forbes, Shelton, McLeod and Tucker -- knowingly or recklessly

caused and allowed CUC and Cendant to make the False Statements..)

360. CUC maintained two corporate offices on Summer Street in Stamford,

Connecticut. In 1997, the offices of the executive officers responsible for finance and investor

) relations were located together on the third floor at 707 Summer Street. Walter Forbes and the

two inside directors that reported directly to him, Shelton and McLeod, were located on the third

floor. Also on the third floor was Corigliano, a key participant in the fraud, who reported)

directly to Shelton. Thus, the CUC inside directors worked closely with those who admittedly

created fictitious financial results.

)

361. Moreover, these defendants had specific access to documents and information

that should have revealed the accounting irregularities to them. They each received or had access

)

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)

to sensitive financial information between 1995 and March 1998 that provided them the

information necessary to alert them to the accounting irregularities that have now been disclosed.

362. Monthly and quarterly packages were prepared by each subsidiary of CUC,

including Comp-U-Card, which contained the actual, unmanipulated results of each subsidiary.)

Had any CUC director examined these basic documents, they would have known that the

consolidated results presented to the Board contained materially inflated results. (Report at 29.)

)

363. In fact, reporting packages which contained monthly accurate data on Comp-

U-Card and other subsidiaries were distributed to various senior executives, including defendants

Walter Forbes, Shelton and McLeod. (Report at 33 n.28; 98 n.107.) As the Report concluded,)

these reporting packages "might have alerted [the recipient] to the fact that the reported quarterly

results substantially exceeded the actual results of the business units." (Report at 98 n.107.)

)

364. Similarly, the subsidiaries submitted annual budgets to various senior CUC

executives during December or early January of each year. The Comp-U-Card division budget

was widely distributed within CUC, including to Corigliano, McLeod and Shelton, among)

others. (Report at 28.) As these reports were unaltered, had the Individual Defendants reviewed

them and compared them to subsequently altered budgets, the discrepancies would have been

) easily identified.

365. In addition to other red flags mentioned herein, Walter Forbes and Shelton

were both directly involved in certain accounting irregularities. For example, Shelton authorized)

more than $500,000 of airplane expenses incurred by Walter Forbes in 1995 and 1996 to be

charged to the reserve established in connection with the CUC/HFS merger in 1997, even though

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there was no connection between the expenses and the merger. (Report at 15-16.) Even

5 assuming the trips were valid business expenses, they should have been charged as an

administrative expense. Improperly charging it to the merger reserve had the effect of decreasing

expenses, thus inflating net income, and, when the reserve was reversed, of inflating revenue.

366. Shelton even personally encouraged certain other accounting irregularities.

Among the most compelling examples is a March 6, 1998 meeting between Scott Forbes, an

) associate of Cendant's president and CEO, defendant Silverman, and Shelton, Corigliano and

other CUC officials, which took place only four days after the completion of the PRIDES

Offering. At that time, Scott Forbes was told by Shelton that TUC wanted [him] to help them

be creative in moving $165 million of Cendant merger reserves into income in 1998," with

Shelton suggesting that "it was a good idea to move the reserves around to various units so that

) they were not sitting on one division's books." (Report at 57.) Such a shift in merger reserves

violated GAAP, as detailed herein, and was part of the pattern and practice of accounting

irregularities ultimately disclosed by Cendant on July 14, 1998 and thereafter.)

367. Open and obvious questions about CUC's accounting practices surfaced in an

event shortly after the consummation of the Merger and before the issuance of the false financial

) information complained of herein. In preparing the December 31, 1997 financial statements for

CUC's subsidiary, CMS, the results for the month of Jaminry 1997, which had previously been

included in the prior year's financials, had to be combined with those for the 11 months ended)

December 31, 1997. In doing so. CUC had to estimate the January results, as it did not prepare

monthly financials in the ordinary course of business. On behalf of CUC, Sabatino subsequently

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5

estimated that CUC's net after-tax income for January 1997 to be approximately $66 million, an

amount substantially higher than the income for an average month in 1997. (Report at 55.)

368. Ippolito, a former HFS officer, noticed that January 1997 CUC income seemed

high in relation to other months, and specifically discussed it with E&Y and Sabatino (CUC Vice

President of Accounting and Financial Reporting) prior to Cendant's Audit Committee meeting

to analyze the results. Remarkably, E&Y was unable to confirm the reasonableness of the

income figure, instead concluding that it had been overstated by $23 million, or by more than a

third of Sabatino's estimate and reported this to the Audit Committee. At a minimum, this

substantial overstatement should have prompted further investigations by the Individual Defen-

dants not already involved in the fraud. Had they done so, they should have discovered what was

ultimately revealed in the Report, that the January 1997 results were "contrived to take advantage

of the change to a calendar year and that [Sabatino] had warned Corigliano the anomaly would

be apparent to the auditors." (Report at 56.) Instead, the overstated calculation was adjusted at

Cendant's Audit Committee meeting, which approved Cendant's February 4, 1998 earnings

announcement, without further consideration of the implications. An obvious "red flag" was

again ignored.

369. Further red flags arose at that same time when, two days before the February 4

earnings announcement, Scott Forbes received a fax from Corigliano containing revised final

1997 revenues for CUC, both quarterly and by segment. After asking his staff to compare these

revised numbers with those received from CUC a week earlier, Scott Forbes was told on

February 3, 1998, that "Rjhere were some significant differences." (Report at 258-59.)

126

370. Forbes, however, claims he accepted Corigliano's assertion that these

0 differences "did not materially affect the bottom line." (Id at 259.) The higher numbers were

ultimately included in the February 4th announcement.

371. Later, on April 9, 1998, Sabatino informed Scott Forbes that the upward

adjustments "lacked factual basis," but had been made "to conform the segment results to

segment information presented to analysts in December 1997, which information was also

incorrect" (Id.) Sattler, who provided the segment information for the presentation to the

analysts, explained that the unsupported segment adjustments were made "to be consistent with

the unsupported quarterly and calendar topside adjustments that had been made." (Id) Thus,

had Scott Forbes not "accepted" Corigliano's word, the fraud would have been exposed.

B. DISCOVERY BY SILVERMAN AND SCIENTER AS TOTHE APRIL 15, 1998 AND APRIL 27, 1998 STATEMENTS

372. By late February, Silverman informed Walter Forbes and Shelton that he

"wanted CUC's business units to switch their reporting from Pember to Scott Forbes" because

"Rifle former HFS personnel felt that they were not getting necessary information and

cooperation from CUC Corporate." (Report at 56-57.) Nevertheless, Silverman conveniently

concurred with Walter Forbes' and Shelton's request that the change occur after the release of

first quarter 1998 results and the 1997 10-K—and, critically, after the dissemination of the false

Registration Statement and Prospectus. (Report at 56-57.)

373. During the month of February, Silverman sold 1.7 million shares of Cendant

stock. (Wall Street Journal, April 17, 1998, at A3.)

127

374. On March 5, only three days after the consummation of the Offering, and a day

before Cendant filed documents with the SEC concerning that consummation, Silverman said

that the "changeover in reporting structure could not wait." (Report at 57.) Walter Forbes and

Shelton finally acquiesced, with Shelton drafting a memorandum that day stating that, "effective

immediately, Scott Forbes will take responsibility for the consolidation of the numbers from the

former CUC divisions" and that the reporting function will move from Anne Pember to Scott

0 Forbes and the divisional CFO's will move their finance reporting relationship directly to Scott."

(Id.) Silverman then instructed Scott Forbes to meet with Shelton on transitional matters. When

Scott Forbes met with CUC officials on March 6, 1998, he became aware of the manipulations

concerning merger reserves and immediately informed Silverman and Mjonaco.

375. After the March 6th meeting, the former HFS officers wanted to know if CUC

had taken merger reserves into income in 1997, and the following day Silverman was informed

by Corigliano that the non-recurring income in the 1997 CUC results could be as high as $100

million. To learn more about this issue, Silverman met with Walter Forbes, Scott Forbes,

Shelton, Monaco and Corigliano on March 8, 1998, and learned that $144 million of CUC's

1997 net income was attributable to "non-operating" or non-recurring items. (Report at 63-64.)

(On March 9, 1998, Walter Forbes sold 300,000 Cendant shares, netting approximately $11.4

million in profit. (Wall Street Journal, April 17, 1998, at A3.))

376. By this date, only six days after the consummation of the Offering, and while

there was still time to take action before any of the PRIDES plaintiffs acquired their PRIDES

securities, there was no longer any doubt that the HFS directors and officers had every reason to

128

suspect the validity of what they had been told by CUC personnel. Yet, they waited for more

than a month before taking further steps—after further damage had been done.

377. Prior to the Offering, Silverman and the other former HFS insiders had seen

the red flags and should have pursued appropriate due diligence. They had sufficient reason to at

least inquire further prior to the preparation and dissemination of the Registration Statement and

Prospectus, yet they did nothing. Given the red flags that were present, the former HFS

personnel could not reasonably have relied on the representations of either E&Y or the CUC

insiders.

378. The publicly available facts relating to Cendant's financial miscues provide a

strong inference of the defendants scienter, i.e., that they knew, or with reckless disregard for

the truth ignored the fact that, their representations from April 15, 1998 onward continued to be

5 false and misleading as a result of misstatements or omissions of material fact.

379. The defendants had a strong motive for downplaying the problems arising from

the accounting irregularities -- their desire to complete the American Bankers transaction, which

was why Cendant made the Offering in the first place, and to avoid the payment of the $400

million cancellation fee due to American Bankers upon temiination of the merger. Cendant and

its senior executives knew that if the full extent of the fraud was revealed, the American Bankers

transaction could not survive. Thus, they hoped that, by at least delaying disclosure of the true

scope of the problem, they would be able to move forward with the transaction as planned.

380. The defendants had sufficient knowledge prior to the April 15 press release to

inform them that the accounting problems were far greater than were disclosed in that release and

)

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could be expected to have long term and material adverse impacts on Cendant and its ability to

consummate the American Bankers merger.

381. In March 1998, for example, Silverman told Walter Forbes that he wanted

Shelton, Corigliano and Lipton to leave Cendant, (Report at 67), in clear recognition of their role

in the manipulation and falsification of CUC's and Cendant's financial records. Subsequently,

Cendant issued a press release on April 8, 1998 to announce their "resignations."

382. As a follow up to these actions, Scott Forbes met with Sabatino and Speaks on

April 9, 1998 to review in greater detail the Comp-U-Card division's 1997 results and 1998

budget. During this meeting, Sabatino reported that for each of the first three quarters of 1997 he0

had recorded a series of "topside" adjustments to increase quarterly earnings, totaling $176

million, which were recorded in consolidating entries at CUC Corporate and not in any operating

units' books. (Report at 68.) Moreover, Sabatino informed Scott Forbes that these adjusting

entries were reversed in the fourth quarter, but that to compensate for the corresponding

reduction in income from these reversals CUC reduced $93 million of Ideon and Cendant

reserves into income without factual substantiation or support, and that other, similar,

adjustments were made by other CUC employees at the direction of Pember. (Id.)

0

383. In addition, Sabatino reported at the April 9 meeting about other "arbitrary

adjustments that had been made to CUC's monthly 1997 results for purposes of reporting on a

calendar year (rather than fiscal year) basis," while Speaks stated that:

Corigliano and Pember had arbitrarily directed that certainmembership products for which revenue recognition was deferred bereclassified as products (such as Privacy Guard) where revenues arerecognized immediately, which had the effect of increasing

130

Comp-U-Card division's 1997 revenues by about $32.8 million abovewhat they would have been absent such reclassification.

(Report at 69.) Sabatino specifically told Scott Forbes that the quarterly topside adjustments had

not been necessitated by CUC's quarterly "soft closes," as had been represented by Corigliano,

but had, in fact, been made "to meet analysts' expectations." (Id. at 68.) As reported in the

Report, "[Netween April 9 and April 15 there was further investigation by Cendant financial

personnel concerning the information Sabatino and Speaks had imparted on April 9," and Speaks

and Sabatino even signed affidavits attesting to the facts they had communicated to Monaco and

Scott Forbes. (Id. at 70.)

384. In the April 15, 1998 press release, Cendant announced that its anticipated

restatement could involve approximately $100 to $115 million. Yet, by this date, Cendant, and

its senior executives, including Silverman, knew that the 1997 financial statements had been

overstated by at least $200 million at a minimum (the $176 million in improper "topside"

adjustments attested to by Sabatino and the $32.8 million in improper revenue recognition

described by Speaks). As this was just the beginning of the investigation, Cendant and

Silverman also knew, or were wilfully ignorant of the fact, that this had to be just the "tip of the

iceberg." These facts support a strong inference that they acted with scienter in disseminating

false and misleading representations and omissions during the Class Period.

X. INAPPLICABILITY OF SAFE HARBOR PROVISION

385. The statutory safe harbor provided for forward-looking statements under

certain circumstances does not apply to any of the allegedly false statements made during the

Class Period as pleaded in this Complaint. The statements alleged to be false and misleading7

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herein all relate to then-existing facts and conditions. These include the scope of the problems

associated with important segments of the company's business, the scope of the accounting

irregularities, and the magnitude of the impact of such irregularities on the company's net

income, which the April 15, 1998, announcement had understated by a quantum of nearly 3. In

addition, to the extent certain of the statements alleged to be false may be characterized as

forward looking, they either were not sufficiently identified as "forward-looking statements"

when made, or were improperly so classified when in fact the material, adverse, conditions

already had materialized.

XI. APPLICABILITY OF PRESUMPTION OF RELIANCE AND FRAUD ONTHE MARKET DOCTRINE

386. PRIDES are a synthetic security that directly derives its value from the value

of Cendant common stock. During the class period, PRIDES and Cendant common stock traded

in an efficient market. The PRIDES met the requirements for listing and were listed and actively

traded on the NYSE, a highly efficient and automated market. Cendant was also registered

pursuant to Section 12 of the Exchange Act (15 U.S.C. § 78(e) and filed periodic public reports

with the SEC and the NYSE.

387. Further, Cendant regularly communicated with public investors by means of

established market communication mechanisms, including regular disseminations of press

releases on the national circuits of major newswire services and through other wide-ranging

public disclosures such as communications with financial press, Dow Jones and other similar

reporting services. Additionally, Cendant securities were followed by securities analysts

employed by major brokerage firms who wrote reports that were distributed to the sales force and

13 2

customers of their respective brokerage firms, many of which were publicly available and

entered the public marketplace. The analysts following Cendant include Merrill Lynch, Salomon

Smith Barney, Donaldson, Lufkin & Jenrette Securities Corp., PaineWebber, Bear Stearns &

Co., and Goldman Sachs & Co. The reports of these analysts were distributed to their customers

and the public at large.

388. As a result, the market for PRIDES promptly digested current information

regarding the Company from all publicly available sources and reflected such information in the

price of the PRIDES. Moreover, the market price of PRIDES responded quickly and decisively

to the adverse news identified in this Complaint, further evidencing the efficiency of the market

for PRIDES. Under these circumstances, all persons who purchased or otherwise acquired

PRIDES during the class period suffered similar injury through their purchase or acquisition of

such securities at artificially inflated prices, and a presumption of reliance therefore applies.

XII. CLAIMS UNDER THE EXCHANGE ACT

SEVENTH CLAIM FOR RELIEFUNDER SECTION 10(b) OF THE EXCHANGE ACT

AND RULE 10b-5(Against Cendant and Certain Individual Defendants)

389. All of the allegations in the preceding paragraphs of this Complaint are

incorporated and restated as if fully set forth herein.

390. This claim is brought pursuant to Section 10(b) of the Exchange Act and Rule

10b-5 against Cendant and Walter Forbes, Shelton, Tucker, McLeod, Corigliano and Silverman

on behalf the Plaintiffs and all persons who purchased PRIDES in the open market from April

16, 1998 through July 13, 1998, inclusive.

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391. This cause of action is for damages incurred as a result of the false and

misleading financial information contained in the consolidated financial statements of CUC (later

Cendant), and other financial reporting, made by Cendant and the above-named Individual

Defendants (except Silverman) and filed with the SEC in the following, hereinafter referred to as

the "False Filings":

Cendant's Form 8-K, filed January 29, 1998

Cendant's PRIDES Registration Statement, filed February 23, 1998

Cendant's PRIDES Prospectus, filed February 26, 1998

Cendant's Forrn 10-K, filed March 31, 1998

392. All of these SEC filings contained consolidated financial statements and other

financial reporting information that was materially false and misleading in the respects and

amounts detailed earlier in this Second Amended Complaint, in the Report, in the Cendant

Complaint, and in the Form 10-K/A filed by Cendant on September 29, 1998, all contained in the

Appendix to this Amended Complaint.

393. The False Filings artificially inflated the market price of PRIDES securities

during the class period by causing the market to overvalue the underlying value of the debt and

equity represented by the PRIDES securities.0

394. The incomplete and misleading disclosure of April 15, 1998 did not dissipate

the effect on the market price of PRIDES caused by three years of fraud. The fraud continued to

affect the market price of PRIDES until it was disclosed on July 14, 1998.

395. In addition, these defendants (except Corigliano), including defendant

Silverman. caused to be issued, or substantially participated in the preparation and issuance of,

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the following materially misleading public statements (more fully described above), and failed to

make disclosures necessary to be made to render the following statements not misleading:

April 15, 1998 Press Release of Cendant Corporation

April 27, 1998 Press Release of Cendant Corporation Containing a Letter toShareholders

(Hereinafter referred to as the "False Releases.")

396. No defendant took any steps to disclose the full extent of the fraud until July

14, 1998. During the period April 15, 1998 to July 14, 1998, Cendant and all Individual

Defendants named above (except Corigliano, who had been terminated) took affirmative steps to

minimize the impact of the April 15, 1998 disclosure on the market price of Cendant's stock, by

making incomplete, misleading, and reassuring statements to the public, and failing to disclose

the full extent of the fraud, thereby prolonging the effects of the three-year fraud on the market

for PRIDES securities.

397. The remaining fraudulent effect on the market price caused by the False Filings

and False Releases was not completely dissipated until the disclosure on July 14, 1998 of the full

extent of the fraud and the full extent of Ceridant's restatement of its financial results for the

period 1995 through 1998. On July 13, 1998, when news of the full disclosure began to leak into

the market, Cendant's common stock price fell 14%. On July 14, 1998, Cendant's stock price

dropped from the previous day's close of $18-7/8 per share to close at $15-11/16 per share on

July 14 reflecting an approximate drop of 17%; the Income PRIDES' price dropped from the

previous day close of $34-3/32 per unit to close at $30-1/4 per unit on July 14, reflecting an

approximate drop of 11%; and the Growth PRIDES' price dropped from the previous day's close

of $29-3/8 per unit to close at $25 per unit on July 14, reflecting an approximate drop of 15%.

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398. Cendant and the Individual Defendants named above, in making the false

statements complained of herein, acted with knowledge of their falsity, or with such reckless

disregard for the truth as to indicate fraudulent intent.

399. Plaintiffs and the other members of the Class did not know, or in the exercise

of reasonable diligence could not have known, of the untruths and omissions contained in the

False Filings and False Releases until July 14, 1998.

400. Plaintiffs and the other members of the Class have sustained damages as a

result of the misstatements and omissions contained in the False Filings and False Releases for

which they are entitled to compensation.

401. Less than one year has elapsed from the time that Plaintiffs discovered or

reasonably could have discovered the facts upon which this Complaint is based to the time of

filing this Amended Complaint.

402. The Individual Defendants named above were personally involved the

preparation of CUC's and Cendant's False Filings and False Releases, and/or either personally or

through an attorney-in-fact signed the False Filings and False Releases, and/or were directors of

Cendant during the period 1995 through March 1998. Due to their signing of the False Filings

and False Releases, and/or their status as directors or persons involved in the preparation of

Cendant/CUC's financial statements, the Individual Defendants were responsible for the contents

and dissemination of the False Filings.

403. As a result of the above described acts, the defendants, severally and in

concert, directly and indirectly, by use of the means and instrumentalities of interstate commerce,

violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder in that they

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knowingly or recklessly (a) employed devices, schemes and artifices to defraud; (b) made untrue

statements of material facts or omitted to state material facts necessary in order to make the

statements made, in light of the circumstances in which they were made, not misleading; or (c)

engaged in acts, practices and a course of business that operated as a fraud or deceit upon the*,1

members of the Class in connection with their purchases of the PRIDES securities.

404. During the Class Period, the PRIDES securities were traded in an active and

efficient securities market by means of a nationwide electronic trading network which instantly

and simultaneously reflects, on thousands of trading screens, computerized market information

concerning stock price and trading activity as well as displaying relevant current data concerning

Cendant supplied by news wire services. In addition, Cendant disseminated the false statements

by the wire services and financial press, and in its periodic public filings with the SEC and its

periodic reports to stockholders.

405. As a result of the deceptive practices and false and misleading statements and

omission described above, the market price of the PRIDES securities was artificially inflated

throughout the Class Period.

406. The members of the Class, relying on the integrity of the market in the

securities and/or the Defendants' misrepresentations, purchased PRIDES during the Class Period

at artificially inflated prices. Had the members of the Class known the truth concerning the

misrepresented and omitted facts described herein, they would not have purchased the PRIDES

securities at the prices they did, if at all. At the time of the purchases by the members of the

Class, the true value of the PRIDES securities was substantially less than the prices they paid for

e,

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them. Accordingly, the members of the Class have been damaged as a result of the defendants'

11) wrongdoing.

EIGHTH CLAIM FOR RELIEFUNDER SECTION 10(b) OF THE EXCHANGE ACT

AND RULE 10b-5(Against Ernst & Young)

407. All previous allegations in this Second Amended Complaint are incorporated

as if fully set forth and realleged herein.

408. This claim is brought pursuant to Section 10(b) of the Exchange Act and Rule

10b-5 against Ernst & Young, on behalf the Plaintiffs and all persons who purchased PRIDES in

the open market from April 16, 1998 through July 13, 1998, inclusive.5

409. Ernst & Young is an independent certified public accountant retained by CUC

to, among other things, audit CUC's fiscal 1996 and 1997 financial statements and conduct

reviews of its quarterly statements. Pursuant to that retention, E&Y issued unqualified opinions

stating that its had audited CUC's financial statements for fiscal years 1996 and 1997 in

accordance with GAAS, and that those statements fairly presented, in all material respects, the

financial condition and results of operations of CUC for those periods, in conformity with

GAAP. E&Y also audited CMS's financial statements for the year ending December 31, 1997,

and issued a similar unqualified opinion with respect to that audit.

410. E&Y expressly consented to the inclusion or incorporation by reference of its

audit reports in all the False Filings detailed above.

411. E&Y's unqualified opinions on CUC's fiscal 1996 and 1997 financial

statements, and CMS's financial statements for the calendar year 1997, were materially false and

misleading. Contrary to its representation therein, E&Y's audit of those financial statements had

138

not been conducted in accordance with GAAS, and CUC's and CMS's financial condition and

results of operations had not been presented fairly and accurately in conformity with GAAP, as

set forth above. Rather, CUC's audited fiscal 1996 and 1997 financial statements, and CMS's

financial statements for the year 1997, contained untrue statements of material facts and failed to

state other facts necessary to make the statements made not misleading, and were in extreme

departure from GAAP, as set forth above, in the Report, in Cendant's Form 10-K/A filed

September 29, 1998, and in Cendant's Complaint, all attached in the Appendix hereto.

412. In addition to the materially false and misleading auditor's reports contained in

the False Filings, E&Y substantially participated in the preparation and filing of the fraudulent

financial statements and other financial reporting contained in those filings by conducting

reviews of interim financial statements and annual audits, rendering accounting advice to CUC

and Cendant concerning the preparation of its financial statements, and in rendering opinions to

CUC and Cendant that it was aware of no material changes necessary to bring CUC's and

Cendant's proposed financial statements, both quarterly and annual, into accordance with GAAP.

413. In addition, E&Y, by rendering accounting services and by advising Cendant

with respect to its restatement of financial results and the content of its disclosures regarding that

restatement, substantially participated in the preparation and making of False Releases.

414. In making and substantially participating in all these false statements, E&Y

acted with knowledge of their falsity, or with such reckless disregard for the truth as to indicate

fraudulent intent.

415. The true scope and extent of the fraud complained of did not become known

until July 14, 1998. Plaintiffs and the other members of the class did not know or in the exercise

139

)

of reasonable diligence could not have known of the full extent of the untruths and omissions

) contained in E&Y's audit reports or the False Filings until July 14, 1998.

416. As a result of the above described acts, the defendant, directly and indirectly,

alone and in concert with others, by use of the means and instrumentalities of interstate)

commerce, violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder

in that it knowingly or recklessly (a) employed devices, schemes and artifices to defraud; (b)

) made untrue statements of material facts or omitted to state material facts necessary in order to

make the statements made, in light of the circumstances in which they were made, not

misleading; or (c) engaged in acts, practices and a course of business that operated as a fraud or)

deceit upon the members of the Class in connection with their purchases of the PRIDES

securities.

417. During the Exchange Act Class Period, the PRIDES securities were traded in)

an active and efficient securities market by means of a nationwide electronic trading network

which instantly and simultaneously reflects, on thousands of trading screens, computerized

market information concerning stock price and trading activity as well as displaying relevant

current data concerning Cendant supplied by news wire services. In addition, Cendant

disseminated the false statements by the wire services and financial press, and in its periodic

public filings with the SEC and its periodic reports to stockholders.

418. As a result of the deceptive practices and false and misleading statements and

omission described above, the market price of the PRIDES securities was artificially inflated

throughout the Class Period.

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419. The members of the Exchange Act Class, relying on the integrity of the market

in the PRIDES securities and/or the defendant's misrepresentations, purchased PRIDES during

the Class Period at artificially inflated prices. Had the members of the Class known the truth

concerning the misrepresented and omitted facts described herein, they would not have0

purchased the PRIDES at the prices they did, if at all. At the time of the purchases by the

members of the Class, the true value of the PRIDES was substantially less than the prices they

paid for them. Accordingly, the members of the Exchange Act Class have been damaged as a

result of the defendants' wrongdoing.

5

141

NINTH CLAIM FOR RELIEFUNDER EXCHANGE ACT SECTION 20(a)

3 (Against Certain Individual Defendants)

420. All previous allegations in this Second Amended Complaint are incorporated

as if fully set forth and realleged herein.

421. This claim is brought pursuant to Section 20(a) of the Exchange Act on behalf

of the Exchange Class of purchasers and acquires of PRIDES between April 16, 1998 and July

13, 1998, inclusive, against Walter Forbes, Shelton, Tucker, McLeod, Corigliano and Silverman.

422. Because of their positions of control and authority at CUC, CMS and Cendant,

defendants held power and influence, and exercised the same, over Cendant, CUC and CMS, and

0were able to and did, directly or indirectly, control the content of the statements relating to

Cendant, CUC and CMS during the period January 1, 1998 through July 14, 1998, (except for

Corigliano, who was terminated as of April 15, 1998 and against whom claims are asserted only

for the False Findings and except for Silverman, against when claims are asserted only for the

False Releases).

423. Moreover, because of their positions with CUC, CMS and Cendant, defendants

had access to adverse non-public information about the financial condition, operations and future

business prospects of the Company as particularized herein and acted to misrepresent and

conceal the same.

424. Therefore, defendants were controlling persons of CUC, CMS and Cendant

within the meaning of Section 20(a) of the Exchange Act and are thereby liable for Cendant's

violations of Section 10(b) and Rule 10b-5 promulgated thereunder.

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XIII. CLASS ACTION ALLEGATIONS FOR ALL CLAIMS

425. Plaintiffs bring this class action pursuant to Fed. R. Civ. P. 23(a), and (b)(3) on

behalf of a Class consisting of all persons who purchased or acquired PRIDES issued by the

Cendant Defendants pursuant to the Registration Statement and Prospectus, which was materially

false and misleading. Such purchases began February 24, 1998 (when the Underwriter

Defendants commenced selling PRIDES) and continued through and including July 13, 1998,

and the class includes those purchasers who sustained damages thereby. The class comprises two

parts: (a) the 1933 Act Class comprised of all purchasers or acquirers of PRIDES from February

24, 1998 through April 15, 1998; and (b) the Exchange Act Class comprising all purchasers or

acquirers of PRIDES in the open market between April 16, 1998, and July 13, 1998, inclusive.

Excluded from the classes are the defendants, any entities in which the defendants or any

excluded person has or had a controlling interest, the officers and directors of Cendant, and the

legal affiliates, representatives, heirs, controlling persons, successors, and predecessors in interest

or assigns of any such excluded party.

1 426. Throughout all relevant time hereto, the PRIDES were actively traded on the

NYSE, with many millions of PRIDES being traded. Record owners and other members of the

classes may be identified from records maintained by Cendant and/or its transfer agent and may

be notified of the pendency of this action by mail and publication, using forms of notice similar

to those customarily used in securities class actions. The members of the classes are so

numerous and geographically dispersed that joinder of all members is impracticable. While the

exact number of class members is unknown at this time and can only be determined by

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7;

appropriate discovery, plaintiffs believe that there are thousands of members located throughout

the United States.

427. Plaintiffs' claims are typical of the claims of the members of the classes

because, like all members of the classes, they acquired the PRIDES either pursuant or traceable

to the Offering or at inflated prices during the Exchange Act Class Period, and were damaged as

a result of the defendants violations of the federal securities laws complained of herein.

428. Plaintiffs will fairly and adequately protect the interests of the classes and have

retained counsel who are experienced and competent in class and securities litigation. Plaintiffs

have no interest that is contrary to or in conflict with those of the members of the classes.

429. A class action is superior to all other available methods for the fair and

efficient adjudication of this controversy, since joinder of all members of the classes is

impracticable. Furthermore, as the damages suffered by individual members of the classes may

be relatively small, the expense and burden of individual litigation make it virtually impossible

for the members of the classes individually to seek redress for the wrongs done to them. There

will be no difficulty in the management of this action as a class action.

430. Questions of law and fact common to the members of the classes predominate

over any questions that may affect only individual members because defendants have acted on

grounds generally applicable to the entire classes. Among the common questions of law and fact

are:

A. whether defendants violated the federal securities laws as alleged;

B. whether the challenged statements omitted and/or misrepresentedmaterial facts, and whether defendants breached any duty to conveymaterial facts or to correct material facts previously disseminated;

144

C. whether the market prices of PRIDES during the class periods wereartificially inflated due to the material nondisclosures and/or

) misrepresentations complained of herein; and

D. whether the members of the classes have sustained damages and, if so,what is the appropriate measure of damages.

)

431. Plaintiffs know of no difficulty that will be encountered in the management of

this litigation that would preclude its maintenance as a class action.

JURY DEMAND 1

432. Plaintiffs demand a trial by jury.

PRAYER

WHEREFORE, the plaintiffs demand judgment against the defendants, and each of

them jointly and severally, as follows:

A. determining that this suit is a proper plaintiff class action pursuant to rule 23 of

)the Federal Rules of Civil Procedure and certifying the plaintiff as class representative and their

counsel as class counsel on behalf of the classes as defined herein;

B. declaring that the defendants violated the federal securities laws, as alleged)

herein;

C. awarding the plaintiffs and the classes damages and/or the right of rescission as

a result of the violations set forth in this complaint, with interest thereon as appropriate;

D. awarding the plaintiffs and the class the costs and disbursements of this action,

including reasonable attomey's fees, as well as costs and fees paid to accountants and other

experts; and

145

)

E. granting such other and further relief as the Court may deem just and proper,

including injunctive relief.

Dated: April 5, 1999 Respectfully submitted,

KIRBY McINEFtNEY & SQUIRE, LLP)

/ -By: n Roger W. Kirby, Esq.

) Alice McInerney, Esq.Andrea Bierstein, Esq.

830 Third Avenue, 10th FloorNew York, New York 10022(212) 317-2300

)Lead Counsel for Plaintiffs

OF COUNSEL:

Stanley M. Grossman, Esq.Shaheen Rushd, Esq.)D. Brian Hufford, Esq.Robert J. Axelrod, Esq.Alan H. Scheiner, Esq.POMERANTZ HAUDEK BLOCK

GROSSMAN & GROSS LLP100 Park Avenue - 26 th FloorNew York, NY 10017(212) 661-1100

Neil Selinger, Esq.) LOWEY DANNENBERG BEMPORAD

& SELINGER, P.C.The Gateway - 11 th FloorOne North Lexington AvenueWhite Plains, NY 10601

) (914) 997-0500

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John Halebian, Esq.WECHSLER HARWOOD

HALEBIAN & FEFFER LLP488 Madison AvenueNew York, NY 10022(212) 953-7400

DAVID B. KAHN & ASSOCIATES, LTD.One Northfield PlazaSuite 100Northfield, IL 60093

G: TILESIC2 WPDOCSNCENDANT12nd.amnd.cmpInt wpd April 1, 1999

0

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