Contract and United Airlines

Cardillo Travel Systems, Inc. ACT 1 Russell metalworker knew why he had been summoned to the office of A. Walter Rognlien, the 74-year-old chairman of the board and pass executive officer (CEO) of smiths employer, Cardillo Travel Systems, Inc. Just both days earlier, Cardillos in-house attorney, Raymond Riley, had requested that Smith, the corporations cookler, sign an affidavit regarding the nature of a transaction Rognlien had negotiated with the unify Airlines.The affidavit verbalize that the transaction involves $203,000 payment by coupled Airlines to Cardillo but failed to disclose why the payment was being do or for what specific purpose the funds would be used. The affidavit included a tilt indicating that Cardillos stockholders uprightness exceeded $3 million, a statement that Smith knew to be incorrect. Smith also knew that Cardillo was involved in a lawsuit and that court injunction issued in the case required the company to maintain stockholders equity of at le ast $3 million.Because of the blatant misrepresentation in the affidavit concerning Cardillos stockholders equity and a sense of uneasiness regarding united Airlines payment to Cardillo, Smith had refused to sign the affidavit. When Smith stepped into Rognliens office on that day in may 1985, he found non only Rognlien but also Riley and two other Cardillo executives. One of the other executives was Esther Lawrence, the firms energetic 44-year-old persistent and chief operating officer (COO) and Rognliens wife and confidante. Lawrence, a long-time employee, had assumed control of Cardillos day-to-day operations in 1948.Rognliens two sons by a previous marriage had left the company in the early mid-eighties following a power struggle with Lawrence and their father. As Smith sat waiting for the clashing to begin, his apprehension mounted. Although Cardillo had a long and proud history, in late(a) years the company had begun experiencing serious fiscal problems. Founded in 1935 an d purchased in 1956 by Rognlien, Cardillo ranked as the fourth-largest company in the travel agency industry and was the head start to be listed on a national stock exchange. Cardillos annual revenues had steadily increased after Rognlien acquired the company, approaching $100 million by 1984.Unfortunately, the companys operating expenses had increased more rapidly. Between 1982 and 1984, Cardillo posted collective losses of nearly $1. 5 million. These poor operating results were largely due to an self-asserting franchising strategy implemented by Rognlien. In 1984 alone that strategy more than doubled the number of travel agency franchises operated by Cardillo. Shortly after the meeting began, the overbearing and volatile Rognlien demanded that Smith sign the affidavit. When Smith steadfastly refused, Rognlien showed him the first page of an unsigned treaty between United Airlines and Cardillo.Rognlien then explained that the $203,000 payment was intend to cover expenses incurre d by Cardillo in changing from American Airlines Apollo system. Although the payment was intended to reimburse Cardillo for those expenses and was refundable to United Airlines if not spent, Rognlien wanted Smith to record the payment at one time as revenue. Not surprisingly, Rogliens suggested treatment of the United Airlines payment would allow Cardillo to meet the $3 million minimum stockholders equity threshold established by the court order outstanding against the company.Without hesitation, Smith informed Rognlien that recognizing the United Airlines payment as revenue would be improper. At that point, Rognlien told Smith that he was incompetent and unprofessional person because he refused to book the united payment as income. Rognlien further told Smith that Cardillo did not need a controller like Smith who would not do what was expected of him. ACT 2 In November 1985, Helen Shepherd, the audit partner supervising the 1985 audit of Cardillo by Touche Ross, stumbled across in formation in the clients files regarding the agreement Rognlien had negotiated with United Airlines earlier that year.When Shepherd asked her subordinates about this agreement, one of them told her of a $ 203,000 adjusting entry Cardillo had recorded in late June. That entry, which follows, had been approved by Lawrence and was apparently linked to the United Airlines-Cardillo transaction Dr ReceivablesUnited Airlines$203,210 Cr Travel Commissions and Fees203,210 Shepherds subordinates had discovered the adjusting entry during their secant-quarter review of Cardillos form 10-Q statement. When asked, Lawrence explanation without attempting to corroborate it with other audit evidence.After discussing the adjusting entry with her subordinates, Shepherd questioned Lawrence. Lawrence insisted that the adjusting entry had been properly recorded. Shepherd than requested that Lawrence asks United Airlines to provide Touch Ross with a confirmation verifying the key stipulations of the agre ement with Cardillo. Shepherds concern regarding the adjusting entry stemmed from information she had reviewed in the clients files that the United Airlines payment to Cardillo was refundable under certain conditions and thus not recognizable directly as revenue.Shortly after the meeting between Shepherd and Lawrence, Walter Rognlien contacted the audit partner. Like Lawrence, Rognlien maintained that the $203,000 amount had been properly recorded as commission revenue during the second quarter. Rognlien also told Shepherd that the disputed amount, which United Airlines paid to Cardillo during the third quarter of 1985, was not refundable to United Airlines under any circumstances. After some prodding by Shepherd, Rognlien agreed to allow her to request a confirmation from United Airlines concerning certain features of the agreement.Shepherd received the requested confirmation from United Airlines on December 17, 1986. The confirmation stated that the disputed amount was refundable through 1990 if certain stipulations of the contractual agreement between the two parties were not fulfilled. After receiving the confirmation, Shepherd called Rognlien and asked him to explain the obvious difference of assent between United Airlines and Cardillo regarding the terms of their agreement with the chairman of the board of United Airlines. Rognlien claimed that pursuant to this confidential business arrangement, the $203,210 would never have to repaid the United.Shepherds conversation with Rognlien refused. In fact, as Rognlien knew, no such agreement existed. A few days following Shepherds conversation with Rognlien, she advised William Kaye, Cardillos vice chair of finance, that the $203,000 amount could not be recognized as revenue until the contractual agreement with United Airlines expired in 1990. Kaye refused to make the appropriate adjusting entry, explaining that Lawrence had insisted that the payment from United Airlines be credited to a revenue account. On December 30, 1958, Rognlien called Shepherd and told her that he was terminating Cardillos relationship with Touche Ross.In early February 1986, Cardillo filled a form 8-K statement with the Securities and Exchange Commission ( due south) notifying that agency of the companys change in auditors. SEC regulations required Cardillo to disclose in the 8-K statement any disagreements involving accounting, auditing, or financial reporting issues with its former auditor. The 8-K, signed by Lawrence, indicated that no such disagreements preceded Cardillos decision to dismiss Touche Ross. SEC regulations also required Touche Ross to draft a letter commenting on the existence of any disagreements with Cardillo.This letter had to be filed as an exhibit to the 8-K statement. In touche Rosss exhibit letter, Shepherd discussed that the improper accounting treatment tending(p) that transaction resulted in misrepresented financial statements for Cardillo for the six months ended June 30, 1985, a nd the nine months ended September 30, 1985. In late February 1986, Raymond Riley, Cardillos legal counsel, wrote Shepherd and insisted that she had misinterpreted the United Airlines-Cardillo transaction in the Touch Ross exhibit letter filed with the companys 8-K.Riley also informed Shepherd that Cardillo would not pay the $17,500 invoice that Touche Ross had submitted to his company. This invoice was for professional services Touche Ross had rendered prior to being dismissed by Rognlien. ACT 3 On January 21, 1986, Cardillo retained KMG Main Hurdman (KMG) to replace Touche Ross as its independent audit firm. KMG presently addressed the accounting treatment Cardillo had applied to the United Airlines payment. When KMG personnel discussed the payment with Rognlien, he informed them to the alleged secret arrangement with United Airlines that superseded the written contractual agreement.According to Rognlien, the secret arrangement precluded United Airlines from demanding a refund of the $203,000 payment under any circumstances. KMG refused to accept this explanation. Roger Shlonsky, the KMG audit partner responsible for Cardillo engagement, told Rognlien that the payment would have to be recognized as revenue on a pro rata basis over the five-year period of the written contractual agreement with United Airlines. Cardillo began experiencing severe liquid state problems in early 1986. These problems worsened a few months later when a judge imposed a $685,000 judgment on Cardillo to resolve a civilised suit filed against the company.Following the judge? s ruling Raymond Riley alerted Rognlien and Lawrence that the adverse judgment qualified as a material event and thus has to be reported to the SEC in a Form 8-K filling. In the memorandum he sent to his superiors, Riley discussed the serious implications of not disclosing the settlement to the SEC My primary concern by not releasing such report and information is that the officers and directors of Cardillo whit ethorn be subject to violation of rule 10b-5 of the SEC rules by failing to disclose information that may be material to a potential investor. Within 10 days of receiving Rileys memorandum, Rognlien sold 100,000 shares of Cardillo stock in the open market. Two weeks later, Lawrence issued a calf love release disclosing for the first time the adverse legal settlement or that Cardillo remained viable only because Rognlien had invested in the company the proceeds from the sale of the 100,000 shares of stock. Additionally, Lawrences evoke release, Roger Shlonsky met with Rognlien and Lawrence. Shlonsky informed them that the press released grossly understated Cardillos estimated loss for fiscal 1985. Shortly after that meeting, KMG resigned as Cardillos independent audit firm.EPILOGUE In May 1987, the creditors of Cardillo Travel Systems, Inc. forced the company into involuntary bankruptcy proceedings. Later that same year, the SEC concluded a lengthy investigation of the firm. The SE C found that Rognlien, Lawrence, and Kaye had profaned several provisions of the federal securities laws. These violations included making false representations to outside auditors, failing to maintain accurate financial records, and failing to file prompt financial reports with the SEC, In addition, the federal agency charged Rognlien with violating the insider trading provisions of the federal securities laws.As a result of these findings, the SEC imposed permanent injunctions on each of the collar individuals that prohibit them from engaging in future violations of federal securities laws. The SEC also attempted to recover from Rognlien the $237,000 he received from selling the 100,000 shares of Cardillo stock in April 1986. In January 1989, the two parties resolved this matter when Rognlien agreed to pay the Sec $60,000