Tyco: Im Sure That Its a Really Nice Shower Curtain

Introduction Dennis Kozlowski was born on November 16, 1946, in New Jersey. The former Tyco CEO received his degree in accounting and finance in 1968, from Seton Hall University. In 1970 Mr. Kozlowski landed his first auditing job with the SCM Corp. in New York City, and it wasnt until 1975 when he joined Tyco. Dennis Kozlowski continues to work for Tyco for the next 27 years where he rose through the ranks to CEO in 1992. Mr. Kozlowski became very well known for his successful mergers and acquisitions as well as being responsible for the Tyco expansion in the early 1990s. In addition to his business successes, Kozlowski also became very well known for his luxurious and extravagant lifestyle, which had landed him an indictment for tax fraud for the purchases of fine art. On June 1st 2002, Kozlowski announce to the Tyco Board of directors that he was under investigation by authorities for tax evasion of sales taxes for the purchase of a painting in Manhattan. At this time, the Tyco Board of Executive demanded that Kozlowski step down from his role as CEO. Two days later as per the boards recommendation, Kozlowski stepped down from his role; as a result he no longer was eligible for the severance package which was valued at almost $120 Million. This case study will explore Kozlowskis motivation for attempting to avoid the sales taxes on his art. In addition, I will explain the concept of commingling assets with respect to the Tyco case, and explain if any adjustments may have taken place in the form of different programs at Tyco. The Financial Troubles Begin In 2002, this became a very difficult time for Tyco, due to the loss in market capitalization which was estimated to cost Tyco $86 Billion. This was mostly due to the concerns which investors had regarding Tycos lack of strategic focus. In addition, many critics were upset over the compensation levels which were provided to Tycos management. In December of 2001, Tycos stock had fallen from $60 a share to

$16.05 a share in June 2002. Around this time, it became known to the public that Tyco had accumulated $27 Billion of debt due to the various and aggressive acquisitions over the years. In the 10 year reign as CEO at Tyco, Kozlowski increased the annual sales from $2 Billion to an amazing $36 billion at the end of the 2001 fiscal year. In addition, Tycos employee staff grew in size worldwide to an estimated 250 000, and had a market capitalization of $120 Billion. At the time of the resignation of Kozlowski, he had accumulated $240 Million in stock options and had an incredible salary which was estimated at over $100 million over the previous three years. It was estimated that the tax which Kozlowski avoided paying on the six paintings was in the neighborhood of $1 Million. As a result, this eventually led to the move of the corporate headquarters from Dexter, New Hampshire to Bermuda. Kozlowski felt that by making this move, it would reduce the Tycos tax liability to 20 %. Paying for Empty Crates According to the prosecutors in the case, Mr. Kozlowski had purchased elaborate paintings which had include a Renoir and a Monet for an estimated $13 Million dollars, which he proceeded to display in his luxurious apartment in New York. In the scheme to avoid the high sales taxes, Kozlowski had the art dealers ship empty crates to Tycos Headquarters in Exeter, and then had the painting moved back and forth from Exeter to Manhattan. As a result of Kozlowskis devious scheme, he was indicted by a grand jury for tax evasion, as well as tampering of evidence and willfully falsifying financial documents. Kozlowski was then ordered to surrender his passport and was released on a steep $3 Million bond. A key piece of evidence which prosecutors discovered, was a fax which had listed the Renoir and Monet paintings, and that the painting were to be shipped to New Hampshire with Wink Wink in parenthesis (Alex Berenson & Carol Vogel, 2002). It was reported that the total cost of the purchases of painting ranging from August to December of 2001 was $15 Million. Karin, Dennis Kozlowskis wife worked with the Art Director to help

purchase the art for Manhattan residence, claiming that she wanted to see how they would appear on the wall prior to making the initial purchases. The first painting purchased was a $4 million dollar Monet, the dealer did not charge the sales tax due to a written document from Kozlowski stating it was going to be shipped to New Hampshire, even though it was shipped to his 5th Avenue apartment which was less than two blocks away from the Art Dealer. A short time later, Kozlowski purchased an additional 4 paintings, this time it included a Renoir. It was estimated that the total cost of these paintings were valued to almost $9 million. For these purchases, Kozlowski instructed the art dealer to ship empty crates which represented the packages of the paintings to New Hampshire, which later were signed and received by Tyco employees. The Investigation Expands In June of 2002, the prosecutors of the Kozlowskis case announced that they planned to expand the investigation to include if Kozlowski utilized Tyco funds to finance his luxurious homes as well if he used the funds for other personal expenses. The investigation began with the attempt to identify how actually paid for the art work hanging in Kozlowskis home in New York. In addition, prosecutors suspected that Kozlowski used Tyco funds to purchase their apartment in Manhattan as a home in Boca Raton, Florida. On June 26, 2002, Kozlowski was indicted on two additional charges which had included the tampering of evidence in the tax evasion case. The basis of this new indictment was based on the disclosure that Mr. Kozlowski falsified the documents which showed the shipments of paintings from New York to New Hampshire prior to the files being sent to the New York District Attorneys office in May of 2002. Dennis Kozlowski pleaded not guilty, same as the previous charges which he had been faced with. The following month in July, of 2002, Tyco had reported a whopping 3rd quarter loss of $2.32 billion, compared to a net profit of $1.18 billion for the third quarter of the previous year. Tycos board

of directors felt it was time to restructure their management team, and hired Motorolas president Edward Breen as CEO and chairman of the board on July 25, 2002. Two months later in September of 2002, Mr. Kozlowski and CFO Mark Swartz were both indicted for illegally obtaining millions of dollars from Tyco, for their own personal use. According to prosecutors the former executives were involved in racketeering and stock fraud. In addition the pair was charged with disbursement of bonuses which were not authorized to their employees as well as falsifying documents of their expense accounts. It was also alleged that both Kozlowski as well as Swartz had paid of the board members and employees in order to keep their fraudulent activities as secret. The prosecutors accused the pair of running a criminal enterprise, this a term commonly used when addressing organized crime. Based on the investigation by prosecutors, it is alleged that Swartz and Kozlowski had stolen $170 million dollars from Tyco and gained an additional $170 million by selling Tyco stock when the price was high due to manipulating financial statement belonging to the company. It was also alleged by prosecutors that Kozlowski used a program which was implemented to assist executives pay taxes on stock options, to improperly borrow money for his personal use which was estimated at $242 million. As a result Kozlowski used the funds to purchase elaborate gifts for his wife, jewelry, real estate and paintings. Swartz allegedly used the same program to borrow $72 million dollars also for his own personal use and various investments. In addition, the pair used an estimated $78 million dollars in the form of loans from the companys real estate relocation program, which was used to purchase personal real estate and other personal expenses. Mark Swartz, Chief Financial Officer Mark Swartz role as Tycos CFO, was more of a deal maker for the companys many acquisitions, more so than the individual responsible for the Tycos financial statements. It was reported that Swartz received a salary of $48 million and an additional $125 million in Tycos stock options. Swartzs

compensation was the highest for a Chief Financial Officer of the time period of 1999 to 2002. Once Swartz was faced with the numerous allegations of fraud, he stepped down from his position of CFO, and gave up the severance package, which was an estimated $100 million, and finally settled on a retirement package of $9 million. On February 19, 2003, Swartz was indicted for tax evasion, it was alleged that he intentionally did not pay taxes on a $12.5 Million dollar loan, which was given to him in early 1999. Key Employee Relocation Program The Tyco employee relocation program was designed to compensate Tycos employees when they were required to move to the New York office. Once the program was approved by Tyco executives, it was alleged that Kozlowski and Swartz saw the opportunity to adjust the scope of the program to their favor. The scope of the program was based on the legal option of a law firm based in Boston, which had concluded if additional benefits were given to executives as part of the relocation program. Swartz and Kozlowski told the Tyco treasurer Barb Miller that the relocation program would now include some additional expenses such as paying for second homes for the Tyco executives as well as paying for private schools for their children. It was alleged that Swartz would give many hand written alterations to the relocation program to Barb, which he felt were the new criteria of the program. Key Employee Loan Program In early 1983, John Fort had assumed the role of CEO, and established the Key Employee Loan Program. The program was instigated in a way that top executives at Tyco may borrow money from Tyco, in order to pay for the taxes on their stock options. The thought behind the program was that Tyco did not want their top executives to be forced to sell their shares in the company stock, in order to pay taxes when they exercised their Tyco stock options. Barb Miller, Tycos former treasurer testified in court that the program was first piloted in 1997, and eventually the scope of the program moved well

beyond the initial purpose.loans for tax payments. A short time after the key employee loan program was implemented, Swartz had a discussion with Miller and stated that the policies of the program has changed, and now executives were able to borrow money from Tyco for any reason, with minimal restrictions. As result, Swartz and Kozlowski proceeded to borrow Tycos money in order to purchase real estate, jewelry and many other personal items for themselves. Kozlowski and Swartz then saw an opportunity to wipe out their loans or forgive them as they stated in court. It was estimated that Kozlowski forgave his loans totaling $37.5 million, while Swartz had his loans forgiven for the amount of $12.5 million. The Payment of Expenses According to prosecutors, Kozlowski approved the forgiveness of $95 million of loans of company employees, in an attempt to keep their silence regarding the fraudulent behavior by himself and Swartz. Tyco also revealed the results of an internal audit, which indicated that Kozlowski used company funds in order to; pay a American express bill of $80,000, a $17, 100 travelling toilet box, a dog umbrella for $15,000, a $6000 sewing kit and the infamous $6000 shower curtain, just to name a few. Karen Kozlowskis Birthday Party Another allegation was made regarding the misappropriate use of company funds was when Kozlowski used $1.5 million of Tycos money to help pay for the $2.1 million dollar birthday party for his second wife Karen. Kozlowski had arranged to have the party in Italy, and was described as having a Roman Empire theme, while Kozlowski posed as the emperor. The party was elaborate including exotic animals, gladiators, and even a sculpture of David which dispersed vodka through its genitals. The entertainment included a performers such as Jimmy Buffet, which also came with a steep price, it was reported that Kozlowski paid $250,000 for his services. The party went on for a entire week, and the guests reported that they did not have to pay for a thing, not even for the flight to Italy. Once the party

was finally over, Karen and a few chosen guests, borrowed the services of the Tyco company jet, and flew to Florence Italy, where they participated in a gourmet cooking class, again on Tycos tab. Tyco Bonus Program In late 2002, the Tyco bonus program was introduced to its employees, although it was not approved by the board of directors. The premise of the loan program was to forgive the relocation loans for the Tyco employees who had purchased homes and moved to the Tyco offices in Florida. Once again, Kozlowski used this program to his benefit, as it allowed him to receive forgiveness for a loan of $33 million from the loan program, while Swartz received $16.6 million. It was estimated that a total of $96 million was paid to approximately 60 employees in the year 2000. The External Auditors It wasnt until February of 2007, when prosecutors accused PricewaterhouseCoopers (PWC) of having knowledge of the Tyco Bonus Program, and did not follow through with an investigation. It was alleged that Swartz and Kozlowski both met with the auditors in regards to the unauthorized transactions, and PWC felt it was unnecessary to have them disclosed within the report. An accountant for PWC by the name of Scalzo was also accused of ignoring the unauthorized loans and bonuses which were given to the top executives. As a result Scalzo agreed to perform due diligence, and agreed that he would not continue to practice as an accountant for the SEC. Scalzo testified in court, that he did review how some of the bonuses and loans were accounted for, although he did not ever verify if the board of directors ever did approve them, simply because it was not part of the auditing procedure. The beginning of the End The first trial against Kozlowski began on September 29, 2003 in Manhattan. The prosecutor accused Swartz and Kozlowski in having in no shame in violating the trust of the Tyco investors. The prosecutor

had also accused the pair of acquiring and utilizing Tyco assets as if it was their and used them for their own personal use. A few months later Tyco had announced that they experienced a $297.1 million dollar loss of that quarter and that they were forced to close 219 operations of Tyco and lay off, 3% of their total workforce, which equated to 7100 employees. On March 18, 2004, the prosecution of the trial against Kozlowski and Swartz had ended, and the jury was sent out to reach a verdict. It initially appeared that the jury would have no issues convicting Swartz and Kozlowski, except for the fact that on juror was holding out, juror #4. On March 26, 2004 juror #4 gave the OK sign to the defense table, as she had been walking past it. Surprisingly, the judge ruled the case a mistrial on April 2, 2004. The judge stated that he had received information that one juror was pressured into convicting Swartz and Kozlowski. As a result, the Manhattan District Attorney immediately announced that there were going to follow through with a re-trial for the Tyco executives. On May in 2004, the jury deliberations had begun for the re-trial against Swartz and Kozlowski. This time it only took the jury 3 weeks to find Tyco executives to be guilty of fraud and falsifying documents, grand larceny and conspiracy. Both Swartz and Kozlowski were convicted on 22 criminal counts and acquitted on only one count of falsifying documents. After the conviction of the Tyco executives, the government had performed an inventory of their assets and determine which assets seized may provide restitution with the proceeds to go back to Tyco and its investors. According to the government, the Swartz and Kozlowski had stolen more than $600 million from Tyco, which also include the illegal stock transactions which the pair were involved in. The sentences placed against Kozlowski and Swartz were on the same terms, they were both sentenced to serve eight years and four months to 25 years for their crimes against Tyco and the investors. The court had also ordered that that Swartz and Kozlowski pay retribution back to Tyco for the amount of $134 million, in addition to $75 million in fines they were both expected to pay.

Questions for Thought 1. What do you think Kozlowskis motivation was for trying to avoid sales taxes on his art purchases was? Explain 2. Explain the concept of commingling assets with repect to the Tyco case. 3. Would of it been possible for the board of directors to see the adjustments taking place in the many different programs at Tyco? Explain

References

Alex Berenson, A. B., & Carol Vogel, C. V. (2002, June 05). Ex-tyco chief is indicted in tax case. The New york times. Retrieved from http://www.nytimes.com/2002/06/05/business/ex-tyco-chief-is-indicted-intax-case.html?pagewanted=all&src=pm