The Pleasure of 'I Told You So'; Shut Out by CUC, a Securities Analyst Is Vindicated

By DIANA B. HENRIQUES Published: August 28, 1998

Robert L. Renck Jr., a Wall Street securities analyst, is a rumpled man with a sad-eyed smile, the sort Hollywood might cast as a middle-aged New York City detective. Always outspoken, Mr. Renck, who rose to be an All-Star Analyst on Institutional Investor's roster, prides himself on asking tough questions of the companies he scrutinizes on behalf of potential investors. And he expects answers. ''If you're going to take the public's money,'' he says, ''you've got to take the public's questions.'' So Mr. Renck was shocked at what happened after he prepared a report seven years ago on CUC International, which operated discount shopping services for members only. Skeptical about the company's profitability and surprised at gaps in its reports to shareholders, Mr. Renck advised investors to sell CUC's shares. CUC's top executives retaliated. They blackballed Mr. Renck, he says, refusing to return his calls or answer his questions. They took him off their mailing list and left him off the guest list for meetings at which they explained their company to analysts. Mr. Renck gave up and left CUC to the many other optimistic analysts whose phone calls were still welcomed -- and whose enthusiastic reports, in many cases, were submitted to CUC before publication, as Mr. Renck had refused to do. Fast-forward to this April 15, when Wall Street was stunned to learn that extensive ''accounting irregularities'' had been uncovered at CUC, which by then had merged with HFS Inc. to form the Cendant Corporation. The irregularities, part of what Cendant now says was a ''systematic fraud'' that had been in place for years, are under investigation by the company, Federal prosecutors and the Securities and Exchange Commission. As the news broke, Cendant's stock fell 46 percent, wiping out $14 billion of stockholders' value. Mr. Renck emphasized that nothing he cited in 1991 suggested any fraudulent behavior at CUC. But for him and others who do Wall Street research, this case of blackballing, while unusual, is by no means unique, and it sends a clear warning. When independent research analysts, who at their best can be the bloodhounds of the American stock market, are muzzled, an important check on public companies is lost. ''Had dissenting analysts been able to ask questions at company meetings and on conference calls, the issues would have gotten out,'' Mr. Renck says of CUC. ''Investors would have started asking about them. The company would have had to deal with it. But when they can selectively ignore a critic, they can keep the issues off the table.''

Other research professionals share Mr. Renck's fear that the threat of being blackballed, and the self-censorship that can breed, is leaving small investors more vulnerable to aggressive accounting, a lack of candor and, in the worst cases, to serious corporate misbehavior. Michael Caccese, general counsel of the Association for Investment Management and Research, the umbrella group for 34,000 financial analysts, explained the problem this way: Most ''sell side'' analysts -- so called because they work for the big brokerage houses that sell stocks to the public -- are reluctant to write negative reports or complain about blackballing. Both, he said, could damage their firm's relationship with the company's chief executive, who may soon be looking to hire a firm to help undertake a lucrative deal or sell a new issue of stock. The National Investor Relations Institute, which represents the corporate executives who deal with Wall Street analysts and investors, opposes the practice of blackballing analysts, said Louis M. Thompson Jr., its president. ''But my sense is that while it is not a prevalent practice, it has happened,'' he said. Even if blackballing is rare in practice, Mr. Caccese and Mr. Thompson agreed, it is a potent theoretical threat, one that can deter aggressive analysis. Walter A. Forbes, who was chairman and chief executive of CUC from 1982 until the Cendant merger last December, refused to comment on any of the issues raised by Mr. Renck. Mr. Forbes resigned from the Cendant board last month but has denied any knowledge of the accounting misdeeds that someone carried out on his watch. The company's board received its audit committee's report on the wrongdoing at a meeting yesterday and released it to the public late in the day. A recent survey by the investor relations group showed that executives at more than 80 percent of leading American companies were shown advance copies of sell-side analysts' research reports, a practice that some say is merely an accuracy check but that Mr. Renck and some other analysts see as an invitation to censorship. Mr. Thompson also cited recent studies that show that negative reports make up barely 1 percent of the analysts' reports at major Wall Street firms. ''Over time,'' Mr. Thompson said, ''the quality and credibility of sell-side research has been called into serious question.'' Big professional investors are already responding by hiring their own professionals -- called ''buy side'' analysts in Wall Street jargon -- to evaluate potential investments. As a result, the consequences of timid sell-side research falls disproportionately on smaller investors who cannot draw on more independent sources of information and analysis. Mr. Renck says he remembers when Wall Street's sell-side research still had some teeth. After receiving his bachelor's degree from St. John's University, he joined the securities firm Bache & Company in 1968, when it was still independent and had a reputation for speaking its mind. In 1974, after earning a master's degree at St. John's and working at Laird Inc., Mr. Renck moved to C. J. Lawrence & Company, where he was selected as a second-string member of Institutional

Investor's all-star team in 1976. In 1979, he joined Oppenheimer & Company, and in 1982 he left to form his own brokerage and research firm, R. L. Renck & Company, which specializes in using an analysis of cash flow -- the cash a company's operations generate -- to find stock market bargains. He had a credible stable of clients by early 1991, and one of them was curious about CUC International, which had already been embroiled in accounting controversy. It claimed all the revenue from the sale of a one-year membership in the first year while writing off the costs of selling that membership over three years -- an approach that sharply raised the profits the company could take on each membership sold. In 1989, bowing to Wall Street pressure, the company adopted a more conservative approach. But when Mr. Renck looked at the company's ledgers in early 1991, he still found practices that surprised him. For example, although the company asserted that 70 percent of its new members renewed at the end of their first year, it provided little detail about the number of shopping-club members who came and went during the year. Renewal patterns were important because the company made almost no money on one-year memberships. Only second-year fees generated any profit, and therefore the timing and frequency with which first-year members renewed was critical information. And while members who canceled were entitled to a full refund, the company's fund to cover such cancellations seemed strangely protean, expanding and shrinking without much logic or explanation. He doubted the company could produce the healthy flow of cash his clients expected. His report's conclusion, therefore, was negative. CUC's management, which had been cooperative before the report appeared, slammed the door on him. Other analysts said the company told them that they considered him to be in league with short-sellers, professional investors who hoped to profit from a decline in CUC's shares by selling borrowed shares and replacing them with cheaper ones later. Mr. Renck complained about his treatment in a letter to Mr. Forbes, CUC's chairman, in the fall of 1991. But he received no response, he said. And so, in early October, he wrote the S.E.C. about his concerns and questions. He never heard back. But soon thereafter, CUC amended its previously issued reports to its shareholders for 1991 and early 1992, a fairly unusual occurrence. One new detail tucked deep into the fine print was an explanation of how the company calculated its renewal rate -- an approach that Mr. Renck said differed from the one that other analysts say they heard from company executives. The newly amended report to shareholders suggested that 70 percent of the members still around at the end of the first year renewed; the Wall Street version suggested that 70 percent of all the members who signed on in the course of a year renewed. Curious, Mr. Renck applied to the commission under the Freedom of Information Act and obtained the correspondence between CUC and the regulators. There he found the agency's repeated demands for information about the comings and goings of members during the year. The company's lawyers, surprisingly, told the commission that CUC did not collect that data and could not present it in the way the agency requested.

Mr. Renck had seen enough to convince him that CUC was ''cutting corners on disclosure and accounting as early as 1991.'' He added, ''They were telling one thing to the S.E.C. about renewal rates and another thing to analysts.'' Looking back, Mr. Renck is the first to say he had not suspected fraud would later emerge at CUC. He had only spotted what he thought were red flags pointing to aggressive accounting and inadequate candor at the company. Mr. Forbes refused to comment on those criticisms. Henry R. Silverman, the chairman and chief executive of Cendant, said that he was not sure that the red flags and uneasy feelings that Mr. Renck identified in 1991 would have ''changed our investment premise,'' even if he had known about them before he merged HFS with Mr. Forbes's CUC late last year. But he has learned that ''many Wall Street analysts were confused'' about the renewal rates and have told him that ''prior management may have given the impression that 70 percent of all the members who signed up renewed.'' His merger team had correctly understood the renewal rate, he added, but the undiscovered accounting irregularities profoundly misled them about the profitability for each member. Mr. Silverman said that no skeptical analyst should worry about being blackballed at Cendant these days -- indeed, Mr. Silverman faces nothing but skeptical analysts in the aftermath of the scandal. While still among the skeptics, Mr. Renck says he thinks the stock is a bargain at current prices. What investors need is more aggressive skepticism in advance of a savings-devouring scandal, research professionals said. ''If we're lucky, the Cendant situation will prompt a re-examination'' of the issues raised by Mr. Renck's experience, Mr. Caccese said. ''It poses a tremendous responsibility on the Street to make sure that analysts have the ability to get the information they need and to report it without undue pressure.'' Photo: Robert Renck was blackballed by CUC International, the members-only shopping service, after a critical report on its accounting practices. (Ruby Washington/The New York Times) Graph/Chart: '''Pervasive' Problems in Accounting Standards'' Graph shows CUC International stock, plotted weekly (after merging with HFS the stock becomes Cendant). JULY 1991 -Robert L. Renck issues a report critical of CUC International's accounting practices. The company responds by blackballing him from meetings. DECEMBER 1997 -- HFS merges with CUC International to form Cendant. APRIL 1998 -- Cendant discloses extensive accounting irregularities at CUC that company officials now say were systematic fraud. YESTERDAY -Cendant releases audit report that blames CUC's former chief executive for creating an atmosphere that contributed to the problems. CLOSE $13.375 Down $1.1875 (Source: Bloomberg Financial Markets)