Corporate Governance Analysis of TYCO

CORPORATE GOVERNANCE ANALYSIS OF TYCO

Corporate Governance Analysis of TYCO Executive Summary Tyco International Ltd. (Tyco), incorporated in 1962 by Arthur J. Rosenberg , is a diversified company, which provides security products and services, fire protection and detection products and services, valves and controls, and other industrial products (Anderson, 2003). On September 12, 2002, Tyco Internationals former chief executive officer (CEO) L. Dennis Kozlowski and former chief financial officer (CFO) Mark H. Swartz arrested and charged with misappropriating more than $170 million from the company. They were also accused of stealing more than $430 million through fraudulent sales of Tyco stock and concealing the information from shareholders (Bianco, Symonds, and Byrnes, 2002). The two executives were charged with more than thirty counts of misconduct, including grand larceny, enterprise corruption, and falsifying business records. Another executive, former general counsel Mark A. Belnick, was charged with concealing $14 million in personal loans. Months after the initial arrests, charges and lawsuits were still being filedmaking the Tyco scandal one of the most notorious of the early 2000s (Anderson, 2003). This Corporate Governance Analysis of TYCO begins with a brief history on company background of Tyco, followed by situation analysis of TYCO. Then it describes executive & board Review followed by an explanation of Tyco CEO L. Dennis Kozlowkis rise to power (White, 2005). As Kozlowki rose to become the second-highest-paid CEO, some red flags pointed toward the impending disaster. Most notably, Kozlowskis aggressive approach to business, his lavish lifestyle, his clashes with the former, more conservative CEO, and his ousting of those who criticized Tycos activities all acted as indicators of Kozlowkis unethical behavior (Anderson, 2003). This analysis also shows how a decentralized corporate structure can make it difficult, even for the board of directors, to

CORPORATE GOVERNANCE ANALYSIS OF TYCO effectively monitor a firms dealings and finances. Finally, an explanation on Corporate

Governance Analysis how Tyco survived the scandal is provided, along with safeguards the company has put into place to ensure that similar misconduct does not occur in the future. Company Background Tyco International Ltd. (Tyco), incorporated in 1962 by Arthur J. Rosenberg, is a diversified company, which provides security products and services, fire protection and detection products and services, valves and controls, and other industrial products. It operates in five segments: ADT Worldwide, Flow Control, Fire Protection Services, Electrical and Metal Products, and Safety Products (Anderson, 2003). The TYCO Companys ADT Worldwide segment designs, sells, installs, services and monitors electronic security systems for residential, commercial, educational, governmental and industrial customers around the world. The Company is a provider of electronic security systems and services. It also provides electronic security services, including monitoring of burglar alarms, fire alarms and other life safety conditions as well as maintenance of electronic security systems (Bray, 2009). The TYCO Companys Flow Control segment designs, manufactures, sells and services valves, pipes, fittings, valve automation and heat tracing products for general process, energy and mining markets, as well as the water and wastewater market. Flow Control designs, manufactures and services a variety of valves, actuators, controls, pipes, fittings and heat tracing products. Valve products include a range of industrial valves, including on-off valves, safety relief valves and other specialty valves (Bianco, Symonds, and Byrnes, 2002). The TYCO Companys Fire Protection Services segment designs, sells, installs and services fire detection and fire suppression systems for commercial enterprises, governmental entities, airports, commercial shipping companies, transportation systems, healthcare owners, petrochemical facilities and homeowners (Panter,2002).

CORPORATE GOVERNANCE ANALYSIS OF TYCO

The TYCO Companys Electrical and Metal Products segment designs, manufactures and sells galvanized steel tubing and pipe products, pre-wired armored electrical cables, electrical support systems and metal framing systems for trade contractors in the construction and modernization of non-residential structures such as commercial office buildings, institutional facilities, manufacturing plants and warehouses, shopping centers and multi-family dwellings (Bianco, Symonds, and Byrnes, 2002). The TYCO Companys Safety Products segment designs, manufactures and sells fire suppression, electronic security and life safety products, including fire suppression products, breathing apparatus, intrusion, security, access control and video management systems. In addition, Safety Products manufactures products installed and serviced by ADT Worldwide and Fire Protection Services (Bray, 2009). TYCO began as an investment and holding company focused on solid-state science and energy conversion. It developed the first laser with a sustained beam for use in medical procedures. Rosenberg later shifted his focus to the commercial sector. In 1964, Tyco became a publicly traded company. It also began a series of rapid acquisitionssixteen companies by 1968. The expansion continued through 1982, as the company sought to fill gaps in its development and distribution networks. Between 1973 and 1982, the firm grew from $34 million to $500 million in consolidated sales. In 1982, TYCO was reorganized into three business segments: Fire Protection, Electronics, and Packaging (Bianco, Symonds, and Byrnes, 2002). By 1986, TYCO had returned to a growth-through-acquisitions model and had restructured the company into four core segments: Electrical and Electronic Components, Healthcare and Specialty Products, Fire and Security Services, and Flow Control, which Tyco maintained through the 1990s. During this time, the company changed its name to Tyco International, in order to signal its global presence to the financial community. By the

CORPORATE GOVERNANCE ANALYSIS OF TYCO early 2000s, the firm had acquired more than thirty major companies, including wellknown firms such as ADT, Raychem, and the CIT Group (Anderson,2003). Situation Analysis TYCO Before the Scandal. Before to the TYCO scandal, the company was one of America's largest conglomerates, with 250,000 employees and operating revenues of 40 billion dollars,

worldwide. TYCO Laboratories began operations in 1960, performing experimental work for the U.S. government (Anderson,2003). The firm went public in 1964 and quickly expanded, mostly by acquisition, to exploit the commercial applications of its work. Dennis Kozlowski joined the company in 1975 as an assistant controller. He diversified the company, branching into health care. Tyco eventually became the second largest producer of medical devices in the United States (Bray,2009). How was the TYCO Scandal Uncovered? The situation began to unfold when the Securities and Exchange Commission was probing into a restatement of the company's stock price. Kozlowski's business practices raised some eyebrows. In 1999, the Securities and Exchange Commission (SEC) initiated an inquiry into Tyco's practices that resulted in a restatement of the company's earnings. In January, 2002, questionable accounting practices came to light. Tyco had forgiven a $19 million, no-interest loan to Kozlowski in 1998 and had paid the CEO's income taxes on the loan (White,2005). It was found that the company's stock price had been overrated, and that the CEO and CFO had sold 100 million dollars' worth of shares, and then stated to the public that he was holding them, which was a misrepresentation and misled the investors (Anderson,2003). The major conspiracy was uncovered by Manhattan District Attorney, Robert Morgenthau, who was investigating Kozlowski for income tax evasion for some fine art work that he had purchased. As Morgenthau kept digging into the record keeping of Tyco

CORPORATE GOVERNANCE ANALYSIS OF TYCO

and Kozlowski, it was determined that there were other situations that had occurred, such as a 10 million dollar loan that was totally forgiven by Tyco, and all interest was billed to the corporation (Anderson,2003). It became apparent on January 29th, of 2002, that there were some bad decisions taking place when it was uncovered that Director Frank Walsh received a 10 million dollar transaction for arranging a purchase of CIT group (Bray,2009). Probably the most disturbing thing of this entire ordeal was that there was not an individual whistleblower. The scandal was caught by groups that were put in place to prevent dishonesty and to protect investors. The problem with this is that the SEC only caught this once it had already spread extensively. If someone would have blown the whistle sooner this would not have been allowed to spread like it did, and would have been caught much sooner (Anderson,2003). Lawsuit against the people When this information was uncovered, the company filed a lawsuit against the people that were involved. Kozlowski hired an attorney that defended his actions, citing his immense charitable donations, from money that he had acquired wrongly. Their defense was that they were corporately responsible people, who were shown as criminals by the media. Kozlowski claimed in court that he had acquired all of his perks and money honestly, and said that he had disclosed all of his actions to the company(Panter,2002). Executive & Board Review Identification of Individuals Responsible for the scandal The primary people that were identified for responsibility of the scandal were Dennis Kozlowski and finance chief, Mark Swartz. Kozlowski joined the company in 1975 as an assistant controller at Tyco. The company subsequently shifted its focus from growth to profits within its three primary divisions: fire protection, electronics, and packaging. He worked in the company during a time of rapid expansion and moved to the board of

CORPORATE GOVERNANCE ANALYSIS OF TYCO directors in 1987, become CEO in 1992, and became chairman of the board in 1993. Kozlowski joined Tyco's board in 1987 and became president and chief operating officer two years later. Kozlowski engineered a coup to become Tyco's chief executive officer (CEO) in 1992 and the chair of the board in 1993 (Bianco, Symonds, and Byrnes, 2002). Mark Swartz was the Chief Finance Officer of the company and worked under Kozlowski. It was determined during trial that the two had worked synonymously in

committing fraud, and working against the shareholders. Both of them ended up receiving the same punishment for their dual efforts in committing the crimes. By the time the dust had settled, 220 of the 250 top managers had been replaced for either not catching the theft, or for allowing it to happen, openly. The remainder of the 250 top managers resigned shortly after. The Rise of Dennis Kozlowski In 1975, armed with a degree in accounting, Dennis Kozlowski went to work for Tyco, following brief stints at SCM Corporation and Nashua Corporation (White,2005). He soon found a friend and mentor in then CEO Joseph Gaziano. However, Gazianos reign ended abruptly in 1982 when he died of cancer. Gaziano was replaced by John F. Fort III, who differed sharply in management style. Where Gaziano had been extravagant, Fort was analytical and thrifty. His goal was to increase profits for shareholders and cut the extravagant spending characterizing Gazianos tenure, and Wall Street responded positively to Tycos new direction (Bianco, Symonds, and Byrnes, 2002). Kozlowski, who had thrived under Gaziano, was forced to adapt to the abrupt change in leadership. Adept at crunching numbers, Kozlowski focused on helping to achieve Forts vision of putting shareholders first. He soon gained Forts attention, and was promoted to president of Grinnell Fire Protection Systems Company, Tycos largest division. He publicly recognized both high and low achievers at a yearly banquet, giving

CORPORATE GOVERNANCE ANALYSIS OF TYCO awards to the best and calling attention to the lowest-producing units (Anderson,2003). Perhaps most importantly, Kozlowski systematically worked to acquire Grinnells competitors. Over the next few years, Kozlowski continued to rise up Tycos corporate ladder. He became the companys president and later CFO. However, his aggressive approach concerned Fort, who wanted to slow the rate of acquisitions in Kozlowskis division. Fort and Kozlowski also disagreed over rapid changes made to Grinnell.

Kozlowski responded by lobbying to convince Tycos board of directors that problems with Wormald were a bump in the road and that the firm should continue its strategy of acquiring profitable companies that met guidelines. The board sided with Kozlowski. In 1992, Fort resigned as CEO and later as chair of the board. Kozlowskis TYCO Empire After Forts departure, Dennis Kozlowski, then 46, found himself helming Tyco International (White,2005). Kozlowski knew Tyco from the bottom up, and stated that he was determined to make it the greatest company of the next century. Among other things, he recognized that one of Tycos major shortcomings was its reliance on cyclical industries, which tend to be very sensitive to economic ups and downs. Kozlowski quickly revived the business and doubled Tycos earnings (Anderson,2003). In 1997, Kozlowski acquired ADT Security Services, a British-owned company located in Bermuda. Kozlowski also restructured Tyco by handpicking a few trusted individuals and placing them in key positions. One of these individuals was Mark Swartz, who was promoted from director of Mergers and Acquisitions to CFO. Swartz, who had a strong financial background as a former auditor for Deloitte & Touche and a reputation for being more approachable than Kozlowski, was aware of Kozlowskis business practices. Kozlowski also recruited Mark Belnick, a former litigator at Paul, Weiss, Rifkind, Garrison & Wharton, to become Tycos general counsel (Panter,2002).

CORPORATE GOVERNANCE ANALYSIS OF TYCO

By this time, Tycos corporate governance system was comprised of Kozlowski and the firms board of directorsincluding Joshua Berman, a vice president of Tyco; Mark Swartz, CFO; Lord Michael Ashcroft, a British dignitary who joined with the ADT merger; James S. Pasman, Jr., from ADT; W. Peter Slusser, also from ADT; Richard S. Bodman, a venture capitalist; Stephen W. Foss, CEO of a textile concern; Joseph F. Welch, CEO of Bachman Company; Wendy Lane, a private equity investor; John F. Fort III, former CEO and chair of Tyco; and Frank E. Walsh, Jr., director of the board. The majority of members had served for ten years or more, and they were familiar with Kozlowskis management style. As directors, they were responsible for protecting Tycos shareholders through disclosure of questionable situations or issues that might seem unethical or inappropriate (White,2005). Meanwhile, Jeanne Terrile, an analyst from Merrill Lynch who worked for Tyco, was not impressed with Kozlowskis activities and Tycos performance. Her job at Merrill Lynch was to make recommendations to investors on whether to buy, hold, or sell specific stocks. After Terrile wrote a negative review of Tycos rapid acquisitions and mergers and refused to upgrade Merrills position on Tycos stock, Kozlowski met with David Komansky, the CEO of Merrill Lynch (Anderson,2003). Although the subject of the meeting was never confirmed, shortly thereafter Terrile was replaced by Phua Young and Merrills recommendation for Tyco was upgraded to buy from accumulate. Merrill Lynch continued as one of Tycos top underwriters as well as one of its primary advisers for mergers and acquisitions. Those who dared to suggest that there were red flags at Tyco were shot down, including Jeanne Terrile at Merrill Lynch and David W. Tice, a short seller who questioned whether Tycos use of large reserves in connection with its acquisitions was obscuring its financial results (White,2005). Corporate Governance Analysis

CORPORATE GOVERNANCE ANALYSIS OF TYCO 10 The Fall of kozlowski and Others In 2002, the New York State Bank Department observed large sums of money moving in and out of Tycos accounts. What made this unusual was that the funds were being transferred into Kozlowskis personal accounts. Authorities discovered that Kozlowski had sought to avoid around $1 million in New York state import taxes (Panter,2002). After purchasing around $14 million in rare artwork, Kozlowski had the invoices shipped to New Hampshire, although the paintings were actually destined for his apartment in Manhattan. To assist in perpetrating the fraud, Kozlowski instructed the shipping company to send empty boxes to New Hampshire along with the invoices. Kozlowski was caught in the act and ended up facing jail time and having to pay out over $100 million in restitutions and back taxes (Bianco, Symonds, and Byrnes, 2002). Learning that he was about to be indicted for tax evasion, Kozlowski resigned as CEO on June 2, 2002. On June 3, he was arrested, but the scandal had barely begun. In September of that year, Dennis Kozlowski and Mark Swartz, who also had resigned, were indicted on thirty-eight felony counts for allegedly stealing $170 million from Tyco and fraudulently selling an additional $430 million in stock options (Anderson,2003). Among other allegations, Kozlowski was accused of taking $242 million from a program intended to help Tyco employees buy company stock. In 2005, Kozlowski and Swartz both were found guilty on twenty-two of twenty-three counts of grand larceny, conspiracy, and falsifying business records and violating business law. Ethical Analysis of the Case There was one victim in this case, the company, Tyco. This victim consisted of the employees, the shareholders and everyone who had a stake in the company at the company. When this theft occurred, the whole company suffered immensely, the stock prices fell sharply, and the people involved are the ones that experience problems (Panter,2002). The illegal and unethical behavior occurred when the CEO and CFO were taking transactions that were not approved by the board of directors. The defendant's actions

CORPORATE GOVERNANCE ANALYSIS OF TYCO 11 were ethically irresponsible because they were stealing money that they were not entitled to from the board of directors and the shareholders of the company. This is something that they were found guilty of, and a normal human being would understand that this is not something that is ethically responsible (Bianco, Symonds, and Byrnes, 2002).Their actions were not socially responsible because there were people, investors, which had trusted the words of the CEO and CFO, believing that they had not sold their shares as they had indicated. When the truth had emerged, they had both sold 100 million dollars of their stock, because they knew that the decisions that they were making were going to cause the stock price to fall and they didn't want to be invested in it. When the stock price did fall, these investors had made bad decisions, based on the information that they were given by the defendants, which was false to begin with. Their actions were not only ethically irresponsible, but socially irresponsible as well (Bray,2009). One of the worst ethical violations that were made in this case was the fact that Kozlowski was telling the shareholders that he rarely, if ever sells his stock. He was doing this so that investors would pump money into the company, but wasn't holding his stock, because he knew that his actions were risky and reckless. By doing this, he led the investors to believe that he was confident in the investment, with all of his inside information, but then turned around and placed his money elsewhere. This made his numbers look good, as investments flowed in, but put all the risk of his bad decisions into the hands of the shareholders who had trusted his word; a lie. Another ethical violation that he made was his donations to charity. I thought that this was the most disgusting part of the whole trial. He kept pleading for leniency based on the amount of money that he had given to charities (Panter,2002). No one seemed to take the time to point out that the money he was donating was stolen from others, and that the donations were really only tax shields for his fraudulent operations. He was acting on the

CORPORATE GOVERNANCE ANALYSIS OF TYCO 12 boards of the non-profits that he donated to and was making money from that as well. His intentions were totally unethical and he played with people for his own personal gain (Bray,2009). When thinking about this, even if the law would have supported the actions of Kozlowski, he was ethically doing things that were incorrect. He was acting in a manner that was not in the best Whiteefit of the common man. On the same principle with ethics, if a person makes an exception to a rule, then that rule applies to everyone else. In this situation, Kozlowski made rules that applied to him, and an elite few that were within his group. By doing this, the principle of, he was binding himself to an agreement that he was willing to be treated that way as well. When the judge ordered him to pay restitution, and sentenced him to jail time it was to pay a fee to humanity to do unto them the way that they needed to be treated (Bianco, Symonds, and Byrnes, 2002). Constitutional protection analysis The constitution granted the subject the Fifth Amendment which is the opportunity to not incriminate them, or to have to testify against them (White,2005). Dennis Kozlowski took advantage of this right during the first trial and waived it in the second trial. His defense team never indicated why this was done, but it was his right to not take the stand if he didn't want to do so. The other protection that he had was the right to due process. This right was given to him, and the first time it appeared that one of the jurors had been bought off so the court worked in favor of having a fair trial and declared a mistrial and moved forward again with new jurors and a new attempt to build a case in favor of defense. The constitution was honored during the proceedings and was legal and fair. Leadership analysis Governance leadership Analysis of TYCO gives Dennis Kozlowski delivered an entire decade of profits and expansions to the business. He acquired CIT Group for 10 billion dollars,

CORPORATE GOVERNANCE ANALYSIS OF TYCO 13 which expanded Tyco into the financial sector. He increased sales by 25%, up to 36 billion dollars in 2002. Perhaps his greatest accomplishment was how he made the business recession proof, by investing into industries like healthcare, which was not a market that Tyco was previously involved in. He was greatly criticized for his decision to invest in fields of business that had not been ventured into before. By doing so, he was able to create growth and expand the business into realms that had never been seen before at Tyco. Kozlowski was more of a leader than a manager (Anderson,2003). That is why the hurt to the company went so deep. He was able to lead in a manner that built loyalty from the people that followed him. He knew how to form teams and create groups and make sure that everyone felt like a family. For this reason, he was able to gain loyalty and got away with far more than if he were only a manager. I do not believe that he qualifies to be a transformational leader, as described below. He did have a strong vision of where the company was headed and caused others to follow that vision. Although at some point, that vision became corrupt, but nevertheless it was a vision and he had a strong following. Kozlowski seemed to be more of a trait leader. He had what people would have thought would make a great leader. He was out front, bold, adventurous, and willing to take risks. He challenged conventional ways of doing things and was not afraid of change. He would have been seen by the majority of shareholders to be a trait style leader (Bray,2009). Conclusion The Corporate Governance Analysis of TYCO scandal offers major lessons for the business world, particularly in areas of corporate conduct. Above all, the story of Dennis Kozlowski shows what happens when too much company power is put into the hands of an individualit can lead to a decentralized corporate structure that makes it difficult to detect misconduct. Governance Analysis of TYCO story also reveals the decreasing tolerance todays government and investors have for misconduct in any form, as even members of Tycos board of directors faced consequences for their unethical behavior (White,2005). Governance Analysis of

CORPORATE GOVERNANCE ANALYSIS OF TYCO 14 TYCO survival proves that some companies can survive major ethical scandals if they take the correct courses of action. In response to the scandal, Tyco took actions that went beyond the bare minimum of what was needed. Although an investigation did not uncover additional fraud, the company still restated its financial results by hundreds of millions of dollars. It took measures to restore shareholder confidence by reorganizing the company and implementing safeguards to ensure greater objectivity on the part of the board of directors. As a result of its quick actions, the company has recovered significantly and has been praised by the public. While the fortunes of Tyco International seem to be on the rebound, former CEO Dennis Kozlowskis fate remains in the hands of the law. After his sentencing in 2005 to twenty-five years in jail for grand larceny, securities fraud, other crimes, and for stealing $137 million in unauthorized bonuses as well as selling $410 million in inflated stock, Regardless of the record that an executive has, there is a need for checks and balances. The directors should have transparency to see what is going on in the corporate levels, and safeguards should be in place to protect the daily workforce from having their pensions and jobs ripped from them due to fraud. Contrary to popular belief, which would have us to believe that a person can achieve a level in life where the law no longer matters, it does. Doing the right thing has a reward, in that a person feels good about what they have done, and the lives that they have touched, but also, doing the wrong thing has a penalty, and not always just a fine.

CORPORATE GOVERNANCE ANALYSIS OF TYCO 15 References Anderson, S. (2003). The fixer: Tyco's new GC tackles an epic cleanup. January 4, 2012 , Business Premiere database. White, B. (2005). Ex-Tyco Officers Sentenced: Pair Get Up to 25 Years in Prison, Must Pay Almost $240 Million, Washington Post. September 20, 2005, D01. Bianco, A., Symonds, W., and Byrnes, N. (2002). The Rise and Fall of Dennis Kozlowski, BusinessWeek. December 23, 2002, 6477. Bray, C. (2009). Ex-Execs Kozlowski, Swartz Appeal to US Supreme Court, Wall Street Journal. April 14, 2009 Panter, G. (2002). The Big Kozlowski, Fortune. November 18, 2002, 123126