Auditing Project

Tyco Fraud Case

Academic Session

(2009-2012)

Specialization

(Finance)

Submitted to

Rashmi Jain

Submitted By

Sangeeta Sanil

Roll no: 45

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. Edward Breen, who replaced kozlowski, removed nine members of Tyco’s international board, 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 Kozlowski, 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. Kieslowski, 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 $2 million dollar birthday parties for Kozlowski’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 the fraud 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.

Tyco fraud

Tyco manufacture a wide variety of products, from electronic components to healthcare products .the conglomerate operates in over a 240,000 people. During 2002, exchange and securities commission began an investigation at Tyco’s top executives. Inquiry into the accuracy of the company’s book began in January. As investigation continues it uncovered that Dennis kozlowski, Tyco 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 Tyco’s employee committed no acts of fraud knowingly. As, a precautionary act however Edward Breen, who replaced kozlowski removed nine members of Tyco’s international board.

Tyco investigation

The following time line chronicles the progress of investigation and indictments against Dennis kozlowski mark Swartz and mark belnick.

January 2002- Question rise about the accuracy of Tyco’s bookkeeping and accounting. Stock value drops 19 percent.

January 29, 2002- kozlowski explain that the $ 20 million paid to frank wolsh 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 500,00 Tyco shares on open market .This move is made as an assurance of the value of Tyco stock.

April 25, 2002- kozlowski explains 96 percent loss share for the quarter ending on March 31, 2002 and outlines unusual cost that affected earnings.

June 3, 2002- kozlowski resigns as CEO of Tyco for personal reasons. John fort is the name of temporary CEO.

June 4, 2002- kozlowski is attempted for attempted tax evasion.

June10, 2002- belnick who was hired on Tyco 1998 as the chief legal officer is fired.

June 17, 2002- Tyco through the law firm of boies.

Schiller and Flexner, begins the process of suing belnick for breach of fidiuacary 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 the failure to disclose of shareholders information on the multimillion dollar loans they borrowed from Tyco.

The SEC asked kozlowski, Swartz and belnick to restore funds they took from tyco’s various forms of undisclosed loans and compensation.

Kozlowski and Swartz were charged with :

Corruption

Conspiracy

Grand larceny

Falsifying records.

The losses they caused Tyco are estimated as $ 600 million.

Belnick is charged with:

Falsifying business records.

Failing to disclose loans to made himself (for the purchase of his Manhattan apartment and Utah home) to investors and Tyco compensation committee.

September 19, 2002-kozlowski is freed on $100 million bail. The bail is paid with a $1oo million bond and secured with $10 million in asset from kozlowski’s ex wife.

Swartz is freed on $50 million bail. The bail is paid with a $50 million and secured with 500,00 of Swartz personal Tyco stock.

Belnick is freed on a $1 million bond.

Tyco continues operation and has replaced many members from its board of directors. Edward Breen the former Motorola executive has replaced kozlowski; David Fitzpatrick, who worked in number of blue

firms, has replaced Swartz and William Lytton the former international paper executive has replaced belnick.

What are the ethical and legal issues in this case?

The ethical and legal issues at Tyco International range from discrimination, accounting fraud, grand larceny. The issues involved cohesion on the part of the CEO, and the members of his team. In addition, they placed great emphasis on placing their own values ahead of what was good for the organization.

What role did Tyco's corporate culture play in the scandal? What roles did the board of directors, CEO, CFO and legal counsel play?

Tyco's corporate culture was driven by the CEO, Dennis Kozlowski

who admired the extravagant and lavish lifestyle lavish of the former CEO, Joseph Gaziano. He took an assertive approach to acquisitions and mergers, which helped Tyco, maintain a 14 year growth within the business units. He viewed himself as the organizations, therefore, conducted business as such.

The Boards of Directors are responsible for protecting Tyco's shareholders interest. In some cases, some of the board members were not aware of the fraud, and other unethical deals that were going on behind the scenes. The board members that were aware, did not bring the issues to the other members of the board, therefore, they were just as guilty of unethical behaviors as the CEO and his direct reports. The reason this could have transpired is probably due to the majority of board members being on the board >10 years, and the relationships that had been established over time.

The CEO, CFO and legal counsel, due to the nature of their positions, were not honest and transparent with the stakeholders concerning the issues relating to the accounting fraud and conflicts of interest. They all engaged in an enterprise of corruption and collusion.

Now we will evaluate the planning function of the Tyco Company and analyze the impact that legal issues, ethics, and corporate social responsibilities have on management planning. The year 2000 was a year marked by scandal over the accounting practices of some of the biggest corporations in the world, including Tyco International Incorporated. Tyco’s top executives were indicted and convicted of fraud charges stemming from both improper accounting practices as well as improper personal use of company funds. The planning strategy of these executives seems to have been more focused on

personal gain than on the best interests of the company and its shareholders. They ignored their responsibilities to the laws governing corporate management and to their investors and employees. Dennis Kozlowski, the chief executive officer, alone plundered the company of over 400 million dollars. Using company funds, he threw a toga party for his wife’s birthday that cost two million dollars. He bought millions of dollars worth of art to decorate his home. He spent six thousand dollars of company money on a shower curtain and 15 thousand dollars on an umbrella stand shaped like a poodle. Unlike most of the companies targeted by those investigations, Tyco survived the scandals and is still in business today because it changed the way that it operates. Three of the factors that influence management planning today are their ability to obtain materials and components for manufacturing, the rate of attrition for their home security products and services and the ongoing litigation and investigations.

The Tyco guide to ethical conduct

The Tyco Guide to Ethical Conduct- has been developed to advice employees on what the correct practices and procedures are, when working for Tyco, the guide also outlines examples of unethical behavior and ways in which it can be reported.

Formulation of the Guide

The Tyco Guide to Ethical conduct was developed in 2003 to help set ethical standards and code of conduct for its employees. The drive to develop this Ethical guide was due to the unethical practices for former CEO Dennis Kozlowski. In 2002, Kozlowski and former CFO Mark Swartz were accused of stealing from the company $170 million and $430 million in stock sales,[1] both executives have been sentenced to jail and have also been forced to pay back some of the money. During Kozlowski’s time as CEO he adopted a strategic incentive scheme to help the aggressive growth of the organization. The scheme is focused on growth and earnings targets and all employees benefit when targets are met. Along with the incentive payments comes responsibility - as well as freedom - for Tyco executives.

Due to the unethical behavior and subsequent sentencing of Tyco’s executives, the new CEO Edward Breen, sought to improve the ethical standards of the company and introduced the Tyco Guide to Ethical Conduct. Tyco International is under constant scrutiny now to ensure that the ethical guidelines are followed and that the company is conducting business in manner which is honest and abides by the laws set down in every country.

Code Topics

The guide covers a number of topics and outlines what types of behavior are acceptable and which is not; it also provides examples of unethical behavior the topics covered in the code are:

1. Equal Employment

Outlines the equal opportunity and fair treatment should extend to all employee, it prohibits discrimination on the basis of age, colour, disability, ethnicity, marital, or family status, national origin, race, religion, sex, sexual orientation, veteran status, or any other characteristic.

2. Harassment-Free Workplace States that certain behavior is not permitted such as, unwelcome conduct, abusive language, aggression or sexual harassment.

3. Substance-Free Workplace Prohibits being in possession or under the influence of alcohol, illegal drugs or other controlled substances.

4. Health, Safety and the Environment Prohibits the possession of weapons, does not allow threats of harm. Enforces that stringent safety procedures, be adhered to at all times and that all operations are in compliance with the applicable environmental laws.

5. Political Activities States employees must comply with all state and local laws regarding participation in political affairs also that employees cannot make contributions of company funds to political parties.

6. Conflicts of Interest Employees must notify human resources if they have any involvement with organizations outside of Tyco, also that employees must make decisions bases on the needs of the company not on personal interests or relationships.

7. Gifts This outlines what kinds of gifts may be acceptable and places a maximum monetary value for these gifts, it also states that employees are expected to disclose any gifts that they receive to the company.

8. Fraud States that intentional acts of fraud are subject to disciplinary action and include things such as: submitting false expense reports, forging or altering checks, inflating sales figures by shipping inventory know to be defective of non-conforming.

9. Antitrust

Looks at ensuring that competition remains free from collusion and unlawful conduct such as: discussing with a competitor price, costs

and production. Restricting the right of a customer to sell or lease a product or service at or above a certain price.

10. Propriety and Confidential Information

Outlines that the company’s proprietary and confidential information not be shared with anyone- including coworkers who may not need to know about it, it discusses the need for protection of intellectual property and financial information.

11. Inside Information and Trading Tyco Securities

Prohibits employees from buying or selling Tyco stock as a result of receiving inside information.

12. The Media and Financial Community

Any communication with the news or media should be directed to the corporate public relations office, this includes discussing speculation on stock price changes, rumors about mergers or acquisitions, management changes or new products, policies, or strategies.

13. E-Mail, the Internet and the Use of Company Property

Discusses the use and duration of E-mail and the internet for personal use, also discusses the use of personal software on company computers, states that equipment is provided to enable employees to perform their jobs and that the use of company property should be for the sole purpose of conducting business related tasks

14. Record-Keeping, Financial and Export Controls

States that financial records and information must follow the U.S generally accepted accounting principles; and effective internal controls. The topic also states that all information must be communicated in an accurate and timely manner, it also discussed

record keeping and retention and how documents and files should be saved.

The code also includes information about where employees can go for help and includes contact information for the toll free Concern LINE, the office ombudsman or alternative contacts such as the human resources department of the corporate governance office.

Application

The ethical guide provides employees with a tool in which they can utilize on a daily basis to enable them to make decisions about what sort of behavior is considered ethical or unethical by the company. The guide ties in closely with Tyco’s vision and values which are; integrity, excellence, teamwork and accountability.

Theory applied in Tyco fraud case:

Ethical egoism falls under the consequentiality theory that claims that moral conduct is determined solely by a cost-benefit analysis of an action’s consequences. The normative claim of ethical egoism is that one should act so as to maximize good and minimize bad for oneself. The foundational claim for this theory is that humans are poorly self-interested and there are no moral demands beyond self-interest, i.e., no obligations to anyone other than ‘myself’. Therefore, under this theory, it is understood that humans should act selfishly if they wish to live healthy and meaningful lives. we can see in this case study too as the CEO think of his own personal interest rather than of the organization. Decisions made are not for the good of the entire industry but for the good of the individual or organizational interest.

In conclusion, I must say that I see many faults in this theory and therefore I do not agree with it. In regards to ethical egoism an individual believes that whatever serves his own interests is morally right. I do not see this as being an efficient way of looking at ethical issues since fulfilling only what’s right for oneself many different problems can come up. Another reason I do not agree.

Solutions

As quality professionals, our ability to acquire, utilize, and maintain reliable and valid databases is at risk and will continue to be at risk at least in the near future. Whether out-and-out fraudulent data are provided to us, or whether we are the victims of data-shaving or data-shading, every quality professional is likely to experience this trend at some point in his or her career. In a larger sense, the ethical behavior of a company is certainly part of the “Quality-with-a-big ‘Q’” that we seek to enhance every day. Creating an ethical culture and enforcing ethical behavior is the function of upper management, not just the quality department, but there are some things within our control that we can do to improve the situation. We believe that the implications of this reality suggest that every quality professional should:

• Establish internal systems for the periodic sampling, review, and assessment of critical databases for reliability and validity

• Ensure that among the guidelines provided to external suppliers, ethical expectations associated with the provision be clearly specified and that the consequences of failure to comply with these basic standards be swift, severe, and unambiguous

• Encourage upper and middle-level management to participate in meaningful education on the process by which ethical decision making in business and industry can be accomplished

Telling employees to “do the right thing” just isn’t effective. Ethical dilemmas are not clear choices between breaking the law and being law-abiding; they are at times complex moral mazes with no easy answers. It is not illegal to place the health of the company and investors’ money into risky investments for short-term profits, but a case can be made that it is unethical. The good news is that these moral mazes can be better navigated if employees are trained in ethical decision-making processes and principles.

The time to avoid the results of unethical behavior is before it occurs, not after. As quality professionals, we learned a long time ago that prevention is superior to inspection. In no area might this be more important than business ethics.

CONCLUSION

. "In the case of Tyco International, we have seen what corporate greed can eventually lead to. After this scandal as well other scandals such as the Enron and WorldCom scandals, many citizens lost trust in corporations. In order to reestablish trust and prevent future executives from acting dishonest, the Sarbanes-Oxley Act was passed, and more internal control are now being implemented. In the future, if an executive is confident enough to try and bypass the regulations and steal money from an organization, he will face even more serious charges. Corporate executives such as CEO's of major corporations are among the most elite members of American society. They are extremely well paid, they have excellent benefits, and they are in the position to bring wealth to their families. Given the amount of money they are already receiving, many would find it

ridiculous that a corporate executive would even consider stealing money. It is important to understand, however, that people with so much pride and ambition often have no limits, and to them, nothing is ever enough. Their greed often gets in the way of their honesty and loyalty to the people around them, resulting in scandals like the one described and demonstrating the need for ethics in business and more acts of government intervention.