Contract and United Airlines

Cardillo Travel Systems, Inc. ACT 1 Russell smith knew why he had been summ unrivaledd to the office of A. Walter Rognlien, the 74-year-old chairman of the board and chief executive officer (CEO) of metalworkers employer, Cardillo Travel Systems, Inc. Just dickens days earlier, Cardillos in-house attorney, Raymond Riley, had pass that smith, the companys controller, crisscross an affidavit regarding the nature of a action Rognlien had negotiated with the get together Airlines.The affidavit stated that the transaction involves $203,000 salary by fall in Airlines to Cardillo but failed to disclose why the payment was being made or for what specific purpose the funds would be used. The affidavit include a averment indicating that Cardillos stockholders equity exceeded $3 million, a statement that Smith knew to be incorrect. Smith also knew that Cardillo was involved in a wooing and that hook injunction issued in the case required the company to insist stockholders equity of at least $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 not exactly Rognlien but also Riley and two other Cardillo executives. One of the other executives was Esther Lawrence, the menages 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 trading operations in 1948.Rognliens two sons by a previous espousals had left the company in the early 1980s following a power struggle with Lawrence and their father. As Smith sat waiting for the encounter to begin, his apprehension mounted. Although Cardillo had a long and proud history, in recent historic period the company had begun experiencing serious fiscal pro blems. Founded in 1935 and purchased in 1956 by Rognlien, Cardillo be as the fourth-largest company in the travel function industry and was the low to be listed on a national stock exchange. Cardillos one-year 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 affix collective detrimentes of nearly $1. 5 million. These poor operating results were mostly due to an aggressive franchising strategy implemented by Rognlien. In 1984 exclusively 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 netherstanding mingled with unite Airlines and Cardillo.Rognlien then excuseed that the $203,000 pa yment was intended to cover expenses incurred by Cardillo in changing from American Airlines Apollo system. Although the payment was intended to reimburse Cardillo for those expenses and was refundable to fall in Airlines if not spent, Rognlien wanted Smith to record the payment immediately as revenue. non 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 untoward. At that point, Rognlien told Smith that he was incompetent and amateurish 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 sheepherder, the analyze follower supervising the 1985 audit o f Cardillo by adjoine Ross, stumbled across information in the lymph glands files regarding the agreement Rognlien had negotiated with United Airlines earlier that year.When guard asked her subordinates about this agreement, one of them told her of a $ 203,000 adjusting accession Cardillo had recorded in recent 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 punt- trace review of Cardillos form 10-Q statement. When asked, Lawrence comment 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 justly recorded. Shepherd than requested that Lawrence asks United Airlines to provide Touch Ross with a det errent verifying the key stipulations of the agreement 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 immediately as revenue.Shortly after the meeting between Shepherd and Lawrence, Walter Rognlien contacted the audit partner. Like Lawrence, Rognlien keep 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 nudge 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 declination 17, 1986. The confirmatio n 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 opinion 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 neer excite to repaid the United.Shepherds conversation with Rognlien refused. In fact, as Rognlien knew, no such(prenominal)(prenominal) agreement existed. A a few(prenominal) days following Shepherds conversation with Rognlien, she advised William Kaye, Cardillos vice president 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 La wrence 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 ( secondment) 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 fiscal 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 gulping 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 given that transaction resulted in mi srepresented financial statements for Cardillo for the six months ended June 30, 1985, and 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 front 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 soon communicate 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 t o 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 liquidity problems in early 1986. These problems worsened a few months later when a judge imposed a $685,000 judgment on Cardillo to resolve a civil suit filed against the company.Following the judge? s public opinion Raymond Riley alerted Rognlien and Lawrence that the adverse judgment qualified as a material showcase and thus has to be reported to the SEC in a lick 8-K filling. In the memorandum he sent to his superiors, Riley discussed the serious implications of not disclosing the resolving power to the SEC My primary concer n by not releasing such report and information is that the officers and directors of Cardillo may be subject to violation of chance 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 promote 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 press 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 unsuccessful pe rson proceedings. Later that same year, the SEC concluded a lengthy investigation of the firm. The SEC found that Rognlien, Lawrence, and Kaye had violated 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 three individuals that prohibit them from benignant in future violations of federal securities laws. The SEC also attempted to call back 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