Tyco: I’m Sure That It’s 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 wasn’t 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 1990’s. 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 board’s 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 Kozlowski’s 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

Tyco’s lack of strategic focus. In addition, many critics were upset over the compensation levels which

were provided to Tyco’s management. In December of 2001, Tyco’s 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, Tyco’s 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 Tyco’s 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

dealer’s ship empty crates to Tyco’s Headquarters in Exeter, and then had the painting moved back and

forth from Exeter to Manhattan.

As a result of Kozlowski’s 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 Kozlowski’s 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 Kozlowski’s 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 Kozlowski’s 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 Attorney’s 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. Tyco’s board

of directors felt it was time to restructure their management team, and hired Motorola’s 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 company’s 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 Tyco’s CFO, was more of a deal maker for the company’s many acquisitions, more

so than the individual responsible for the Tyco’s financial statements. It was reported that Swartz

received a salary of $48 million and an additional $125 million in Tyco’s stock options. Swartz’s

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 Tyco’s 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, Tyco’s 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 Tyco’s 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 Kozlowski’s Birthday Party

Another allegation was made regarding the misappropriate use of company funds was when

Kozlowski used $1.5 million of Tyco’s 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 Tyco’s 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 wasn’t 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 Kozlowski’s 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-in-tax-case.html?pagewanted=all&src=pm