Tyco

Until 2002, Dennis Kozlowski, the chief executive of Tyco, International, had been one of the most celebrated CEOs in the United States. Although he was well known for his public pronouncements claiming devotion to high standards of corporate governance, in private he was charged with having diverted more than $135 million in Tyco funds for his own personal benefit. In addition, Kozlowski was charged with misrepresenting Tyco’s financial condition to investors in order to boost its stock price as he sold $575 million in the firm’s stock.

According to The Wall Street Journal, diverted funds were used to purchase an art collection and lavish real estate in Florida, New York, and New Hampshire. Kozlowski and Tyco’s chief financial officer Mark Swartz were charged and tried for diverting these funds. During one of their trials, evidence was presented that Kozlowski had spent $2 million on a party for his wife on the Mediterranean island of Sardinia and that he had purchased a $15,000 umbrella holder and a $6,000 shower curtain for an $18 million apartment that they used but that Tyco owned.

At their trials, the attorneys prosecuting Dennis Kozlowski presented evidence that Tyco’s board of directors did not approve these extraordinary payments. In his defense, Kozlowski argued that the board was well aware of the payments, that they constituted normal compensation, and that the board did approve them. Jurors were not persuaded by this argument, and in June 2005, both Kozlowski and Swartz were found guilty of grand larceny and conspiracy, falsifying business records and violating general business law.

Tyco used PricewaterhouseCoopers LLP (PWC) as their auditing firm. Their annual auditing fees were in the vicinity of $16 million, and nonauditing services were another $32 million. Richard Scalzo was PWC’s lead auditor on the Tyco account. In August 2003, the SEC barred Richard Scalzo from auditing publicly listed companies, describing his auditingwork at Tyco as “reckless.”The SEC criticized Scalzo for failing to examine Tyco’s executive compensation payments such as forgiven loans totaling $96 million, and other related-party dealings that were not disclosed toTyco’s shareholders.

The SEC expressed concern that in 1998, Mr. Scalzo’s auditing team discovered these issues just before Tyco was to announce its year-end earnings. Correcting the accounting treatment would have led Tyco’s quarterly earnings to fall by $40 million, causing the firm to miss analysts’ earnings forecasts. However, rather than insist that Tyco comply with proper accounting conventions, Mr. Scalzo helped Tyco to manipulate its accruals in order to mask the problem. That is, the lead auditor cooperated with the firm’s management in keeping the firm’s audit committee and its investors uninformed about executive compensation.

Case Analysis Question

1. Contrast events at Tyco with the events at HealthSouth described in the chapter. In what ways were the events similar and in what ways were they different?