Tyco Fraud Case

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. •

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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.

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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 •

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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.

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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.