The Tyco Scandal

Introduction

Before the scandal, Tyco was the largest conglomerate in the US worth $38 billion of operating revenue and employing more than 240000 people. Tyco began operations in 1960 offering laboratory services to the US government and went public in 1964. The primary divisions of the company were electronics, fire protection, and packaging. It realized rapid expansion by acquiring other companies and exploiting commercial applications. Dennis Kozlowski was employed in Tyco as an assistant controller in 1975.

Kozlowski rose to join Tyco’s board and became president in 1989. In 1992, Kozlowski masterminded a coup and installed himself as chief executive officer (CEO) and the chair of the board one year later. He introduced the health care segment. Tyco rose to become one of the America’s largest producers of medical devices.

A scandal began in Tyco when the three senior executives embarked on a series of unethical practices. They awarded themselves hefty bonuses without the approval of the compensation committee. The executives irregularly borrowed interest-free loans that they did not qualify. They inflated the price of acquisitions and transferred the titles of the company properties at depreciated book values. This paper examines the Tyco scandal and asserts that it was a result of unethical practices.

Masterminds of the Scandal

Three people represent the greatest responsibility for the scandal. The first is Dennis Kozlowski, who held the positions of assistant controller, and later CEO. He led vicious acquisitions and had a flashy lifestyle. The second was Mark Swartz, who served the positions of the Chief Finance Officer and director at different times of the scandal. Kozlowski and Swartz collaborated to commit fraud. Mark Belnick served as the Executive Vice President. He helped to launch fraudulent initiatives of Mr. Kozlowski and swindled the Board Committees from realizing the fraud (Gini & Marcoux, 2009).

The Fraudulent Activities

At the time of the scandal, Dennis Kozlowski, the CEO of Tyco, was using company money to finance his flashy lifestyle. He took $2 million from the company to celebrate his wife’s 40^th birthday. Moreover, Kozlowski cooperated with Swartz to loot the company. The fraud drew the attention of the U.S Securities and Exchange Commission (SEC) who published the improper conduct of management in September 2002 and revealed the scam in September 2002. The fraud lasted for about five years, and Kozlowski hid the activities from the Board and other committees (Gini & Marcoux, 2009).

Relocation Programs

Kozlowski, Swartz, and Belnick took interest-free loans that they did not qualify and drew unauthorized funds that other employees could not access. The trio bought real estate property using the irregularly acquired grounds relocation loans. Kozlowski corruptly took a $29,756,000 non-qualifying relocation loan, which he used to construct a home in Florida, and improperly borrowed another $7,012,000 to purchase an apartment in New York City (Gini & Marcoux, 2009). These loans did not get the approval of the Board.

Bonus Misappropriation

Kozlowski influenced Tyco to pay bonuses worth $56,415,037 to 50 employees who still had relocation loans. The three masterminds awarded themselves compensation enough to discharge their tax liability. The compensation amounted to $148,000,000 (Gini & Marcoux, 2009). The bonuses were not approved by the Board or the Compensation Committee. In addition, the benefits were also discriminatory as they applied to only a small clique of the staff.

ADT Automotive Bonus Misappropriation

Kozlowski influenced Tyco to pay cash awards of the Tyco common stock’s restricted shares and taxes of 17 officers and employees without the authorization of the Compensation Committee (McIntyre, 2010). Kozlowski swindled the senior executives to believe that ADT Automotive bonus was recognized by program council.

Key Employee Loan (KEL) Program

In this program, the executive officers borrowed money to pay the taxes. In Tyco, a section of executives took loans that exceeded their maximum allowable limits. Kozlowski and Swartz took KEL loans exceeding $ 250 million, and used them for personal interests rather than putting them into uses that could benefit the company (McIntyre, 2010).

Unauthorized Credits to KEL Accounts

Kozlowski and Swartz attempted to clear outstanding debt from KEL accounts without notifying or seeking the approval of the Compensation Committee. The total amount of money involved in this scandal was $ 37,5 million (Gini & Marcoux, 2009). Kozlowski admitted that he did not seek the Board’s approval for a borrowed at KEL.

Executive Compensation

Belnick, then the Chief Corporate Counsel, drew compensation amounting to $ 34,331,679 within three years resulting from a secret agreement with Kozlowski. Belnick dished undisclosed incentives to facilitate Kozlowski to divert Tyco’s funds for personal uses (Gini & Marcoux, 2009). The two forged letters to show this agreement were signed by Kozlowski. Belnick kept the letters in his private office to hide the information from Tyco Board, the Compensation Committee, and the Resource Department.

Perquisites

Kozlowski and Swartz added an extra $50,000 to their annual earnings (Gini & Marcoux, 2009). They were to report the excess earning to the proxy, but they did not. Instead, they restored more enterprises exceeding the amounts but did not return the extra income to the company. Tyco later discovered that Kozlowski used the property in North Hampton and New Castle for his personal use.

Evidence Tampering

For the five years of the scandal, Kozlowski systematically abused his position and influenced Tyco to use funds in areas of his personal interest, which contravened the interest of the company. The trio was aware that they were mismanaging the shareholders’ funds, and, therefore, could be brought to prosecution. They embarked on tampering of evidence including confiscating crucial documents (McIntyre, 2010).

Bargain Sale

In 1998, Kozlowski instructed a Tyco subsidiary to purchase a cooperative apartment worth $5,547,248 in New York City and directed the subsidiary to renovate it. Kozlowski later purchased the apartment without the approval by the Board. It happened two years after the apartment was purchased at a depreciated book value of $7,011,669 (McIntyre, 2010). The price was far much lower than the market value. The low book value was a loss of revenue for Tyco.

Overvaluation of Property

Kozlowski presided over a Tyco subsidiary to purchase a property in New Hampshire for $ 4,500,000. The purchase was made without disclosing to or seeking the approval of the Board. An appraisal was done two years after the purchase had established the value of the property at $1,500,000. On the trial, Tyco noted the carrying and the appraised value of the property. Kozlowski’s could later be charged $3,049,576 as recovery for the overpayment (Gini & Marcoux, 2009).

Non-Legitimate Business Expense

Kozlowski spent the company’s millions of dollars to finance his personal activities and interests during the five years. He invested $700,000 in the film “Endurance”; more than $1 million in unclear business expenses, $134,113 for a private venture, $72,042 for jewelry, $155,067 for clothing; $96,943 for office flowers, and $52,334 for wine (Gini & Marcoux, 2009). These irregular expense reimbursements were costly to the company and wasted resources that could be invested in profitable ventures.

Charitable Contribution

During the Relevant Period, Kozlowski made Tyco donate or pledge to charitable organizations financial support totaling over $106 million. Only $43 million worth of donations was made in transmittal letters or as Kozlowski’s personal donations (Gini & Marcoux, 2009). Hence, Kozlowski used these funds for his personal benefit.

Walsh Payment

In 2001, Frank Walsh, a lead Director of Tyco proposed the acquisition of CIT, a financial services company. To facilitate the acquisition, Walsh suggested introducing Kozlowski to the CEO of CIT. Ultimately, the negotiations that followed led to Tyco’s acquisition of CIT. After the completion of the terms of CIT acquisition, Kozlowski influenced the Board to pay Walsh a fee of $20 million for his contribution to the transaction (McIntyre, 2010).

Breach of Nominee Agreement

Swartz lived in an apartment owned by Tyco in New Yolk since 2000. Two years later, he influenced Tyco to enter in its records a notation to transfer the title of the apartment with fixtures and furniture to Swartz’s name at a value of $9,646,975, which was lower than the market price and initial value of the property (McIntyre, 2010). Tyco did not conduct an appraisal for this transfer. Swartz then paid the price in cash. The transfer of title for the apartment was also not authorized. However, Tyco did not convey the title to the apartment to Swartz. On discovery of the malpractice in late 2002, the transaction was reversed, and Tyco credited the account of Swartz with the amount of money he had paid for the apartment.

Personal Expense Reimbursement

In 2002, Swartz influenced Tyco to pay him $ 1,2 million as reimbursement covering lost deposits because of a failed real estate personal transaction. Neither the board nor the Compensation Committee approved this transaction (McIntyre, 2010). This improper reimbursement is an embezzlement that Tyco launched a suit to recover.

Discovery of the Scandal

The investigations by SEC began in 1999 after an analyst reported inconsistent accounting practices. The investigation was based on the company’s compliance with accounting practices in its acquisitions. However, the initial investigation did not recommend any actions. Consequently, in early 2002, analysts questioned the accuracy of bookkeeping in Tyco. The $20 million paid to the director Walsh was explained as the finder’s fee for CIT group acquisition. In 2002, Kozlowski was under investigation for tax evasion citing failure to pay $13 million for a property he purchased in New Yolk using Tyco funds (Neal, n.d). By the end of 2002, the three masterminds of the scandal had resigned from Tyco. They were charged for failure to disclose the particulars of loans amounting to millions of dollars to shareholders. The SEC demanded that Kozlowski, Belnick, and Swartz should return the funds they irregularly borrowed and awarded themselves from Tyco (Neal, n.d).

Prosecution of the Scandal Masterminds

In 2005, the courts found Kozlowski and Swartz guilty of three offenses. The first offense was awarding themselves bonuses amounting to $120 million without the Board’s approval. The second offense was an abuse of the employee loan program, and the third was a misinterpretation of the financial condition of the company to investors to increase the stock price. The two were sentenced between 8 to 25 years in prison. Belnic only paid a civil penalty of $ 100,000 for his involvement in the scandal (Neal, n.d). Tyco replaced the Board of Directors and rose to become strong again.

Comments

The main issue in the Tyco scandal was a conflict of interests. Kozlowski was both the Chairman of the Board and the CEO. The management could have elected an independent person as a Chairman of the Board to avoid conflict of interest. The company also lacked ethical corporate culture. The company should set a code of conduct to explain its ethical standards that all employees and executives should observe. The employees should be trained on issues related to accounting fraud, financial impropriety, and bribery. The company should employ a regular, thorough audit of its accounts to identify any questionable accounting practice before it evolves to a scandal.

Conclusion

Ethical issues are common in most companies. The ethical issues in Tyco included misappropriation of funds, bribery, conflict of interest and accounting fraud. The ethical issues caused Tyco the problem of unsustainability. Unethical conducts can ruin the financial performance of a company. Therefore, a company should ensure that all employees and executives follow the code of conduct. A company should also encourage whistleblowing and thorough independent audits on financial statements for early detection of the malpractices.

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