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Case Study: Tyco

Tyco Background
Tyco International has operations in over 100 countries and
claims to be the world's largest maker and servicer of electrical
and electronic components; the largest designer and maker of
undersea telecommunications systems; the larger maker of fire
protection systems and electronic security services; the largest
maker of specialty valves; and a major player in the disposable
medical products, plastics, and adhesives markets. Since 1986,
Tyco has claimed over 40 major acquisitions as well as many
minor acquisitions.
How the Fraud Happened
According to the Tyco Fraud Information Center, an internal
investigation concluded that there were accounting errors, but
that there was no systematic fraud problem at Tyco. So, what
did happen? Tyco's former CEO Dennis Koslowski, former CFO
Mark Swartz, and former General Counsel Mark Belnick were
accused of giving themselves interest-free or very low interest
loans (sometimes disguised as bonuses) that were never
approved by the Tyco board or repaid. Some of these "loans"
were part of a "Key Employee Loan" program the company
offered. They were also accused of selling their company stock
without telling investors, which is a requirement under SEC
rules. Koslowski, Swartz, and Belnick stole $600 million dollars
from Tyco International through their unapproved bonuses,
loans, and extravagant "company" spending. Rumors of a
$6,000 shower curtain, $2,000 trash can, and a $2 million dollar
birthday party for Koslowski's wife in Italy are just a few
examples of the misuse of company funds. As many as 40 Tyco
executives took loans that were later "forgiven" as part of Tyco's
loan-forgiveness program, although it was said that many did
not know they were doing anything wrong. Hush money was
also paid to those the company feared would "rat out"
Kozlowski.
Essentially, they concealed their illegal actions by keeping them
out of the accounting books and away from the eyes of
shareholders and board members.
How it Was Discovered
In 1999 the SEC began an investigation after an analyst reported
questionable accounting practices. This investigation took place
from 1999 to 2000 and centered on accounting practices for the
company's many acquisitions, including a practice known as
"spring-loading." In "spring-loading," the pre-acquisition
earnings of an acquired company are underreported, giving the
merged company the appearance of an earnings boost
afterwards. The investigation ended with the SEC deciding to
take no action.
In January 2002, the accuracy of Tyco's bookkeeping and
accounting again came under question after a tip drew attention
to a $20 million payment made to Tyco director Frank Walsh,
Jr. That payment was later explained as a finder's fee for the
Tyco acquisition of CIT. In June 2002, Kozlowski was being
investigated for tax evasion because he failed to pay sales tax on
$13 million in artwork that he had purchased in New York with
company funds. At the same time, Kozlowski resigned from
Tyco "for personal reasons" and was replaced by John Fort. By
September of 2002, all three (Kozlowski, Swartz, and Belnick)
were gone and charges were filed against them for failure to
disclose information on their multimillion dollar loans to
shareholders.
The SEC asked Kozlowski, Swartz, and Belnick to restore the
funds that they took from Tyco in the form of undisclosed loans
and compensations.
Where Are They Now?
Kozlowski and Swartz were found guilty in 2005 of taking
bonuses worth more than $120 million without the approval of
Tyco's directors, abusing an employee loan program, and
misrepresenting the company's financial condition to investors
to boost the stock price, while selling $575 million in stock.
Both are serving 8 1/3-to-25-year prison sentences. Belnick paid
a $100,000 civil penalty for his role. Since replacing its Board
Members and several executives, Tyco International has
remained strong.
The difference in the Tyco case and some of the others is that it
is more related to greed than accounting fraud. For more
information on cooking the books and related topics, check out
the links on the next page.
Tyco Fraud
Tyco manufactures a wide variety of products, from electronic
components to healthcare products. The conglomerate operates
in over a hundred countries around the world and employs
240,000 people. During 2002, the Securities and Exchange
Commission began an investigation of Tyco's top executives.
Inquiries into the accuracy of the company's books began in
January. As investigations continued it was uncovered that
Dennis Kozlowski, Tyco's former CEO; Mark Swartz, Tyco's
former CFO; and Mark Belnick, the company's chief legal
officer, had taken over $170 million in loans from Tyco without
receiving appropriate approval from Tyco's compensation
committee and notifying shareholders. For the most part these
loans were taken with low to no interest. Many of them were
offset as bonuses without open approval. Kozlowski and Swartz
also sold seven and a half million shares of Tyco stock for $430
million without telling investors. Formal charges were made by
the SEC September 12, 2002.
Tyco has been able to regain much in lost ground under its new
leadership. Because the acts of securities fraud committed by
former Tyco executives were concealed and, for the most part,
disguised, the majority of the Tyco's employees committed no
acts of fraud knowingly. As a precautionary act, however,
Edward Breen, who replaced Kozlowski, removed nine
members of Tyco's original board.
Tyco Investigation
The following timeline chronicles the progress of investigations
and indictments against Dennis Kozlowski, Mark Swartz, and
Mark Belnick.
• January 2002 - Questions rise about the accuracy of
Tyco's bookkeeping and accounting. Stock value drops 19
percent.
• January 29, 2002 - Kozlowski explains that the $20
million paid to Frank Walsh was a finder's fee for the
acquisition of CIT.
• January 30, 2002 - Kozlowski announces that he and Mark
Swartz (Tyco's then CFO) will each purchase 500,000 Tyco
shares on the open market. This move is made as an
assurance of the value of Tyco stock.
• April 25, 2002 - Kozlowski explains a 96-cent loss per
share for the quarter ending on March 31, 2002 and
outlines unusual costs that affected earnings.
• June 3, 2002 - Kozlowski resigns as CEO of Tyco for
personal reasons. John Fort is named the temporary CEO.
• June 4, 2002 - Kozlowski is indicted for attempted tax
evasion.
• June 10, 2002 - Belnick, who was hired on to Tyco in 1998
as its chief legal officer, is fired.
• June 17, 2002 - Tyco, through the law firm of Boies,
Schiller & Flexner, begins the process of suing Belnick for
breach of fiduciary duty and fraud. Belnick maintains that
he acted with integrity as Tyco's chief legal officer.
• August 1, 2002 - CFO Swartz resigns from Tyco.
• September 12, 2002 - Civil charges are filed against
Kozlowski,Swartz, and Belnick by the SEC for failure to
disclose to shareholders information on the multi-million
dollar loans they borrowed from Tyco.
The SEC asks Kozlowski, Swartz, and Belnick to restore funds
they took from Tyco in various forms of undisclosed loans and
compensations.
Kozlowski and Swartz are charged with:
• Corruption
• Conspiracy
• Grand larceny
• Falsifying records
The losses they caused Tyco are estimated at $600 million.
Belnick is charged with:
• Falsifying business reports
• Failing to disclose loans made to himself (for the purchase
of his Manhattan apartment and Utah home), to investors
and Tyco's compensation committee
September 19, 2002
• Kozlowski is freed on $100 million bail. The bail is paid
with a $100 million bond and secured with $10 million in
assets from Kozlowski's ex-wife.
• Swartz is freed on $50 million bail. The bail is paid with a
$50 million bond and secured with 500,000 of Swartz's
personal Tyco stock.
• Belnick is freed on a $1 million bond.
Tyco continues operations and has replaced many members of
its board of directors. Edward Breen, the former Motorola
executive, has replaced Kozlowski; David Fitzpatrick, who
worked in a number of blue chip firms, has replaced Swartz; and
William Lytton, the former International Paper executive, has
replaced Belnick.