[SOLVED] Dennis Kozlowski was a dominant, larger-than-

Dennis Kozlowski was a dominant, larger-than-life CEO of Tyco International, Ltd, a multi-billion-dollar company whose shares are still traded on the New York Stock Exchange (Symbol: TYC). His stature was huge, and his appetite for excess knew no bounds. Noted author Tom Wolfe, who wrote Bonfire of the Vanities, which profiled such men, says that “if you feel you are a master of the universe, then a lot of rules just don’t apply,”1 and this quote seems to apply well to Kozlowski.
Kozlowski was rolling along—often using company money—having lavish parties, planes, and cars and enjoying multiple homes with fittings such as a $6,000 shower curtain and a $15,000 umbrella stand, a yacht, and an impressive art collection. It was his interest in art that triggered the first investigation in January 2002 by New York State officials who asked about the sales tax on several multi-million-dollar paintings.2 Kozlowski had evaded the payment of sales tax on them and was subsequently first charged in a New York court.
For Dennis, this was most unfortunate because on conviction, he would serve time in the New York prison system instead of a federal prison in which white-collar criminals often are assigned to facilities known as “Club Feds” or, for women such as Martha Stewart, “Camp Cupcake.” The New York prison system is very harsh. According to former New York prosecutor David Gourevitch, “The fed system is unpleasant, but at least you’re physically safe there.… In the state system, nobody would say you are physically safe.”3 For Kozlowski and his associate Mark Swartz, his Tyco CFO who faced up to thirty years in prison, this prospect was surely daunting.
On the other hand, Kozlowski had certainly enjoyed high living, so many observers would argue he got what he deserved. Take the $2 million 40th birthday party for his new wife on the Mediterranean island of Sardinia, more than half of which was paid for by Tyco. Jurors were shown an edited twenty-one-minute version of a four-hour videotape covering the whole week with seventy-five guests. The short version did not show inflammatory scenes, such as “an anatomically correct ice sculpture of Michelangelo’s David spurting vodka,”4 scantily clad and unclad dancers, and so on. Music was provided by Jimmy Buffet and his group at a cost of $250,000 and a rock band at a cost of $20,000.5 No wonder Kozlowski was charged with looting the company.
The SEC also took an interest, and charges for civil fraud regarding looting of the company and other misdeeds were laid on September 12, 2002. By the time of the trial in October 2003, Tyco was estimated to have about 270,000 employees and $36 billion in annual revenue derived from many sources, including electronic and medical supplies and the ADT home security business.6 A full list of the charges against Kozlowski and CFO Mark Swartz as well against chief legal officer Mark Belnick is outlined in the SEC complaint, which is available at http://www.sec.gov/litigation/complaints/complr17722.htm.
An abbreviated version of the improper conduct of management was published by Tyco in their SEC 8-K information filing with the SEC on September 17, 2002. The Tyco press release7 states,
The Company said that this pat- tern of improper and illegal activity occurred for at least five years prior to June 3, 2002, when former CEO
L. Dennis Kozlowski resigned, and that this activity was concealed from the Board and its relevant commit- tees. The nature of such conduct, to the extent it is now known by Tyco, is described in the filing. The areas cov- ered in this filing include:
• Relocation programs, under which certain executive officers, including Mr. Kozlowski, former CFO Mark Swartz and former Chief Corporate Counsel Mark Belnick used the Com- pany’s relocation program to take non-qualifying interest-free loans and unauthorized benefits that were not generally available to all salaried employees affected by relocations. Under the program, Mr. Kozlowski improperly borrowed approximately
$61,690,628 in non-qualifying relocation loans to purchase real estate and other properties, Mr. Swartz borrowed approximately $33,097,925 and Mr. Belnick borrowed approximately
$14,635,597.
• The “TyCom Bonus” misappropriation, in which Mr. Kozlowski caused Tyco to pay a special, unapproved bonus to 51 employees who had relocation loans with the Company. The bonus was calculated to forgive the relocation loans of 51 executives and employees, totaling $56,415,037, and to pay compensation sufficient to discharge all of the tax liability due as a result of the forgiveness of those loans. This action was purportedly related to the successful completion of the TyCom Initial Public Offering. The total gross wages paid by the Company in this mortgage for- giveness program were $95,962,000, of which amount Mr. Kozlowski received $32,976,000 and Mr. Swartz received $16,611,000. These benefits were not approved by, or disclosed to, the Compensation Committee or the Board of Directors. However, the employees who received these bonuses were led by Mr. Kozlowski to believe that they were part of a Board-approved program.
• The “ADT Automotive Bonus” misappropriations, in which Mr. Kozlowski authorized Tyco to pay cash, award restricted shares of Tyco common stock, and purportedly forgive additional loans and make related tax payments to approximately 17 Tyco officers and employees—even though the relocation loans of each of these 17 persons had already been paid in full. Mr. Kozlowski and Mr. Swartz received cash bonuses, restricted shares and “relocation” benefits valued approximately $25,566,610 and $12,844,632 respectively. These benefits were not approved by or disclosed to the Compensation Committee or the Board of Directors. As with the TyCom unauthorized bonus, other senior executives were misled by Mr. Kozlowski to believe that the ADT Automotive award of restricted shares was a Board- approved program.
• The Key Employee Loan (KEL) Pro- gram, in which certain executive officers borrowed money for purposes other than the payment of taxes due upon the vesting of restricted shares, or borrowed in excess of the maximum amount they were permitted under the program. Mr. Kozlowski was, by a large margin, the greatest abuser of this program. By the end of 2001, Mr. Kozlowski had taken over 200 KEL loans—some for millions of dollars and some as small as $100—and his total borrowings over that time exceeded $250 million. Approximately 90% of Mr. Kozlowski’s KEL loans were non-program loans, which he used to fund his personal lifestyle, including speculating in real estate, acquisition of antiques and furnishings for his properties (including properties purchased with unauthorized “relocation loans”) and the purchase and maintenance of his yacht. Mr. Swartz also borrowed millions in non-program loans. Like Mr. Kozlowski, Mr. Swartz used those unauthorized loans to purchase, develop and speculate in real estate; to fund investments in various business ventures and partnerships; and for miscellaneous personal uses having nothing to do with the ownership of Tyco stock. Tyco is currently evaluating the KEL program in light of recent enactment of a prohibition upon loans by public companies to directors and executive officers.
• Attempted Unauthorized Credits to Key Employee Loan Accounts, in which Mr. Kozlowski and Mr. Swartz attempted to erase an outstanding $25 million KEL indebtedness to Mr. Kozlowski and $12.5 million in KEL indebtedness to Mr. Swartz with- out the knowledge or approval of the Compensation Committee. Mr. Kozlowski, through his attorneys, has acknowledged to Tyco that he sought no approvals for these credits and that, if they were entered as a credit to his KEL account, it was done so improperly, and that he is therefore obligated to repay these amounts to Tyco. Mr. Swartz has also agreed to repay his forgiven indebtedness with interest and has repaid most of the amounts. Tyco has reversed these entries and a related unauthorized entry, thereby increasing the outstanding balances for the key employee loan accounts of each individual involved.
• Executive compensation, including authorized and unauthorized compensation to Mr. Belnick, which totaled $34,331,679 for the years 1999–2001. Belnick’s compensation resulted from a secret agreement that tied Mr. Bel- nick’s compensation to Mr. Kozlowski’s compensation, thereby giving Mr. Belnick an undisclosed incentive to aid and facilitate Mr. Kozlowski’s improper diversion of Company funds to Mr. Kozlowski’s personal benefit. The undisclosed terms of Messrs. Kozlowski’s and Belnick’s agreement were incorporated in a letter dated August 19, 1998 and signed by Mr. Kozlowski. Mr. Kozlowski and Mr. Belnick agreed that the letter would not be disclosed to the Tyco Board, the Board’s Compensation Committee or the Tyco Human Resources department. Mr. Belnick did, however, keep a copy of the undisclosed agreement in his personal office.
• Perquisites in excess of $50,000 per year for Mr. Kozlowski and Mr. Swartz. These perquisites were required to be reported in a proxy to the extent they exceeded $50,000. However, these amounts were not reported in the proxy because Mr. Kozlowski and Mr. Swartz rep- resented that they would reimburse the Company for amounts in excess of $50,000. However, in most cases Messrs. Kozlowski and Swartz failed to reimburse the Company for all perquisites in excess of $50,000. Mr. Kozlowski also caused Tyco to make available to him various properties that the Company owned for his purported business use. Tyco has now discovered that Mr. Kozlowski periodically made personal use of properties in North Hampton, NH, Boca Raton, FL, New York City and New Castle, NH.
• Self-Dealing Transactions and Other Misuses of Corporate Trust, including Tyco properties purchased by or from Mr. Kozlowski without disclosure to or authorization by the Compensation Committee. For example, Mr. Kozlowski and others caused a Tyco subsidiary to purchase property in Rye, New Hampshire from Mr. Kozlowski on July 6, 2000 for $4,500,000. After an appraisal in March 2002 valued the property at $1,500,000, Tyco wrote down the carrying value of the property to the appraised value and charged Mr. Kozlowski’s $3,049,576 overpayment to expense. Mr. Kozlowski also used millions of dollars of Company funds to pay for his other personal interests and activities, including a $700,000 investment in the film “Endurance”; more than $1 million for an extravagant birthday party celebration for his wife in Sardinia; over $1 million in undocumented business expenses, including a private venture; jewelry, clothing, flowers, club membership dues and wine; and an undocumented
$110,000 charge for the purported corporate use of Mr. Kozlowski’s personal yacht, “Endeavour.” Mr. Kozlowski also tampered with evidence under subpoena, purchased a New York City apartment at its depreciated rather than its market value, and took personal credit for at least $43 million in donations from Tyco to charitable organizations.
Not surprisingly, Tyco announced that it had launched a civil lawsuit against Kozlowski for breach of fiduciary duties and fraud and other wrongful conduct and other lawsuits against executives considered complicit in these schemes. This brings to three the major suits faced by Kozlowski launched by New York, the SEC, and Tyco but does not include class action suits by aggrieved investors. Tyco also began to replace its board members.
On June 17, 2005, fifty-eight-year old Kozlowski and forty-four-year old Swartz were each convicted of twenty-two of twenty-three counts, including grand larceny, conspiracy, and securities fraud, and eight of nine counts of falsifying business records.8 On September 21, 2005, Kozlowski and Swartz were sentenced to up to twenty-five years in prison. Many observers thought that was about right, but others, including business leaders, thought it to be too much. In comparison, it was pointed out that some violent crimes, such as rape and manslaughter, carried a sentence of twenty years in jail.9
In a related announcement, the SEC and the lead auditor of Tyco, Richard Scalzo, a partner with PricewaterhouseCoopers (PwC), agreed that Scalzo was permanently barred from preparing financial statements of publicly traded companies. The Tyco account was reportedly worth $100 million per year to PwC, and they retained the audit. The SEC found that Scalzo “was ‘reckless’ and stood idle as the conglomerates leading figures manipulated accounting entries to conceal their lavish spending and pay.”10
Questions
1. The pattern of illegal and improper conduct described above took place for at least five years prior to June 3, 2002. What red flags or governance mechanisms should have alerted the following people to this pattern?
a. Tyco management accountants
b. Tyco internal auditors
c. Tyco external auditors
d. Tyco board of directors
2. Identify and discuss the most important weaknesses in Tyco’s internal controls and its governance systems.
3. Would a post-SOX whistleblowing pro- gram to the Audit Committee of the board have eliminated the improper and illegal actions? Why or why not?
4. If you have been a professional accountant employed by Tyco during this time and you wanted to blow the whistle, who would you have gone to with your story?
5. Why were so many Tyco employees willing to go along quietly with the looting by senior executives?
6. How many years in jail do you think Kozlowski should have received for his white-collar crimes?

Question: Dennis Kozlowski was a dominant, larger-than-