Tracking the Tyco Flock
... from Boston to Bermuda
Sightings from The Catbird Seat
~ o ~
March 23, 2005
Court: Insurance Co. Must Pay Legal Fees
A company that insured Tyco International Ltd. executives must pay legal bills for former CEO L. Dennis Kozlowski, who is on trail on corporate-looting charges, an appeals court says.
In a 5-0 ruling, the state Supreme Court Appellate Division left open the possibility that Federal Insurance Co., a subsidiary of Chubb Corp., could later recover some of the costs from Kozlowski.
The lower court judge had ruled that Federal, which provided liability coverage to Tyco, was required to pay Kozlowski’s legal bills.
The appeals court modified the ruling to say Federal was obligated only to pay legal costs of defending covered claims, and could later be repaid for the legal costs of defending noncovered claims.
Federal lawyer David J. Hensler said Wednesday he had argued the policy’s “personal profit exclusion” applied to some claims against Kozlowski because the former CEO was accused of enriching himself by some of his crimes.
The appeals court wrote Tuesday in its 19-page opinion, “Federal must pay all defense costs as incurred, subject to recoupment when Kozlowski’s liabilities, if any, are determined.”
Kozlowski, 58, and Mark H. Swartz, 44, Tyco’s former chief financial officer, are accused of stealing $170 million from Tyco by hiding unauthorized pay and bonuses and by abusing loan programs. They also are accused of making $430 million by inflating the value of Tyco stock by lying about the company’s finances....
In February 2003, Kozlowski notified Federal of the civil and criminal cases against him and demanded that the insurer pay his defense costs. Federal responded by canceling the liability policies and returning Tyco’s premiums.
Federal tried to void the coverage while claiming that Kozlowski, Tyco’s CEO from January 1992 until June 2002, had misstated information about the company’s finances and other matters in his insurance application.
Kozlowski sued Federal, saying the allegedly false statements were filed with the federal Securities and Exchange Commission, and that a clause in the policies barred Federal from attributing the statements to him.
The appeals court agreed with the lower court that Federal had to pay until its claims had been litigated....
Tyco, which has about 250,000 employees and $36 billion in annual revenue, makes electronics and medical supplies and owns the ADT home security business. Nominally based in Bermuda, its operations headquarters are in West Windsor, N.J....
The Joy of Cooking Books...
January 28, 2004
Auditor Concern Arises
at Tyco Trial
Lawyers for the former chief executive of Tyco International, L. Dennis Kozlowski, asked a New York judge to keep prosecutors from asking the company’s former outside accountant about his lifetime ban from auditing public companies.
The former accountant, Richard P. Scalzo, was barred from auditing public companies in a settlement with the Securities and Exchange Commission. The judge, Michael Obus of State Supreme Court in Manhattan, said he was inclined to bar prosecutors from asking Mr. Scalzo about the subject at the fraud trial of Mr. Kozlowski and Tyco’s former chief financial officer, Mark H. Swartz.
The S.E.C. accused Mr. Scalzo of “recklessly” issuing fraudulent audits after ignoring evidence that executives were looting Tyco. Mr. Kozlowski and Mr. Swartz have been on trial since September, charged with stealing $170 million by hiding bonuses and secretly arranging for the forgiveness of company loans.
Mr. Scalzo’s role as the partner at PricewaterhouseCoopers overseeing Tyco’s audits has been a crucial issue. Defense lawyers said that bonuses the two men were accused of stealing from Tyco were disclosed to Mr. Scalzo.
A lawyer for Mr. Kozlowski told jurors at the start of the trial that Pricewaterhouse gave the “Good Housekeeping Seal of Approval” to the payments.
$ $ $
January 30, 2004
Tyco Auditor Discusses Bonuses
The New York Times
The former lead auditor of Tyco International testified yesterday that he had informed a board committee about bonuses paid to the former chief executive, L. Dennis Kozlowski, which prosecutors say were stolen from the company.
The auditor, Richard P. Scalzo, formerly the PricewaterhouseCoopers partner overseeing Tyco’s audit, testified for a second day in State Supreme Court in Manhattan in the fraud trial of Mr. Kozlowski and the former chief financial officer, Mark H. Swartz.
Mr. Scalzo said he could not recall anyone the audit committee reacting with surprise or objecting to the bonuses.
“I don’t recall any questions from them,” Mr. Scalzo said....
The two men are accused of stealing $170,000 million by corrupting company loan programs and taking unauthorized bonuses. Defense lawyers say the payments were disclosed to Mr. Scalzo and the board and therefore were appropriate....
< < < FLASHBACK < < <
December 30, 2002
Tyco Finds Errors, No
Significant Fraud
By Tim McLaughlin
BOSTON (Reuters) - Tyco International Ltd., battered this year by scandal and accounting worries, on Monday said an internal investigation found no fraud, but uncovered $382 million in accounting errors.
While Tyco (NYSE:TYC) said the errors did not represent significant or systemic fraud, the Bermuda-based conglomerate admitted previous management used aggressive bookkeeping to boost results. The results also confirmed some of the suspicions that have been dogging Tyco since 1999.
Tyco's stock is down about 74 percent this year.
Tyco said the company kept shoddy records and had inadequate corporate governance policies during the reign of indicted former chairman Dennis Kozlowski.
In fact, Kozlowski's personal assistant authorized restricted stock awards and investigators found internal memos using terms such as "financial engineering" in discussions on how to meet profit goals.
To correct the accounting errors, Tyco said it would take pretax charges totaling $382 million in the 2002 fiscal year, which ended Sept. 30. Of that amount, more than half stemmed from Tyco's ADT burglar alarm business, which recognized income too soon from fees it charged a network of independent dealers who sell and install security systems.
Tyco CEO Edward Breen, chief financial officer David FitzPatrick and outside auditor PriceWaterhouseCoopers signed off on the company's fiscal 2002 financial statements, according to the annual report.
Shares of Tyco rose to $15.95 in Instinet trade on Monday from a closing price of $15.35.
AGGRESSIVE ACCOUNTING
Aggressive accounting is not necessarily improper. But the Tyco investigation concluded former management was not neutral in its treatment of accounting policies. It sought out techniques that would boost profits while shying away from those that would reduce them, the report said.
Specifically, the report said prior management manipulated its accounting for acquisitions to boost its financial results. This long-running criticism of the conglomerate was central to an earlier probe by the Securities and Exchange Commission which ended in July 2000 with the body taking no action.
The SEC began another investigation into Tyco's accounting earlier this year. No results have been reported.
As part of Tyco's internal accounting investigation, Tyco reviewed 15 acquisitions that were valued at about $30 billion at the suggestion of the SEC.
Tyco said it completed more than 700 acquisitions between 1999 and 2001.
The report questioned accounting surrounding the acquisitions of electronics companies AMP and Raychem and health care company U.S. Surgical. Tyco boosted earnings in the companies it was acquiring by artificially reducing revenue or increasing expenses in the quarter immediately before the deal closed. The effect was that earnings were enhanced after the acquisition.
One example showed that Tyco understated by $235 million the value of equity and employee stock options it issued to acquire medical product maker Mallinckrodt Inc. in 2000. This meant a $5.6 million overstatement in fiscal 2001 earnings because of the related goodwill.
"There were also instances where senior management exerted pressure and provided incentives which had the purpose and effect of encouraging unit and segment officers to achieve higher earnings, including in some cases by their choice of accounting treatments," the Tyco report stated.
Tyco said $185.9 million of the $382.2 million in errors for fiscal 2002 were a result of miscalculation of reimbursements to dealers of its ADT burglar alarms.
Earlier this year, Tyco hired lawyer David Boies, who prosecuted the Justice Department's antitrust case against Microsoft Corp. (Nasdaq:MSFT) during the Clinton administration, to conduct an internal investigation.
Boies and an army of forensic accountants stepped in as New York City prosecutors investigated Tyco's former chairman, Kozlowski, and his top lieutenant, ex-finance chief Mark Swartz.
The men are accused of orchestrating a corruption scheme that netted them more than $600 million through unauthorized compensation and fraudulent stock transactions.
Both men have pleaded innocent to the charges.
(Additional reporting by Philip Klein in New York)
December 11, 2003
Ex-Tyco Executive Describes
Plan to Hide Bonus Payments
By Bloomberg News
A former Tyco International executive told jurors yesterday how he booked bonus payments on orders from the former chief executive, L. Dennis Kozlowski, and the former chief financial officer, Mark H. Swartz.
Prosecutors contend the bonuses were stolen from the company.
Mark Foley, Tyco's former senior vice president for finance, said he recorded a series of bonus payments to Mr. Kozlowski, Mr. Swartz and other top executives in larger corporate transactions, like the spinoff of subsidiary TyCom in 2000.
Mr. Foley said he had several conversations with Mr. Swartz about the TyCom bonuses, which were paid in the form of mortgage loan forgiveness.
"I was told it was related to the successful I.P.O. of the TyCom business," Mr. Foley said, describing the explanation for forgiving $95.9 million in loans to the executives.
Mr. Foley's testimony gave jurors a first-hand account of how bonus payments were buried in corporate transactions like the TyCom spinoff and the sale of Tyco's ADT Automotive unit in 2000.
Prosecutors accuse Mr. Kozlowski and Mr. Swartz of stealing $170 million and deceiving Tyco's directors and investors by secretly arranging to hide bonuses and forgive loans.
Mr. Foley said Mr. Swartz told him in 1999 that $38.5 million in loans to Mr. Kozlowski, Mr. Swartz and the former Tyco events planner, Barbara Jacques, had been forgiven. Mr. Swartz said the bonuses were related to Tyco's relocation of its corporate headquarters to New York City in 1997.
"He told me that Mr. Kozlowski had told him that certain loans were being forgiven by the board," said Mr. Foley, who left Tyco earlier this year.
Three directors have already testified that they never approved the bonus payments in dispute.
Under questioning by the assistant district attorney, Marc Scholl, Mr. Foley said only Mr. Swartz and the former human resources director, Patricia Prue, told him the bonuses had board approval.
Mr. Foley was among the executives to receive bonuses. He told jurors he received $600,000 in the ADT sale and a special $1 million bonus in 2000 for helping fend off a Securities and Exchange Commission inquiry. Mr. Foley, who earned more than $16 million at Tyco from 1999 to 2002, also said a $1.2 million loan to him was forgiven in the TyCom spinoff.
Mr. Foley said Mr. Swartz called to tell him about the S.E.C. bonus, which was described as a "thank you" for dealing with the inquiry into Tyco's accounting practices.
The S.E.C. closed the investigation without taking any action.
August 14, 2003
Tyco Gets Subpoenaed
on Retirement Plans
Reuters
The U.S. Department of Labor has subpoenaed Tyco International Ltd. as part of a probe of losses at its employee retirement funds, the conglomerate said on Thursday.
Tyco said in a regulatory filing with the U.S. Securities and Exchange Commission that the Labor Department had served document subpoenas on it and Fidelity Management Trust Company.
“The current focus of the Department’s inquiry remains the losses allegedly experienced by the plans due to investments in our stock,” Tyco said, adding that it was fully cooperating with the inquiry....
Fidelity Investments spokeswoman Anne Crowley said the company is responding to the subpoena. She said the company served as trustee and record keeper for the Tyco 401 (K) plan and acted in accordance with the plan sponsor’s instructions....
Renewed suspicions over Tyco’s accounting have dogged the company over the past two years. Tyco’s stock plummeted last year amid a mushrooming criminal investigation against former Tyco leaders, including former Chairman Dennis Kozlowski.
Last month, Tyco Chairman Edward Breen was forced to restate 5-1/2 years of financial statements after saying such a move would be unnecessary.
$ $ $
March 13, 2003
Tyco CEO to Clean House; Plants to Close
By Tim McLaughlin
NEW YORK (Reuters) - Tyco International Ltd. (NYSE:TYC - news) on Thursday said it would close 300 plants over three years, cutting $1 billion in costs by 2006, and its chairman vowed to clean the "crap" from the sprawling conglomerate after unearthing accounting problems in Europe and Asia.
Tyco's shares plunged 12 percent as investors realized Tyco's persistent accounting problems were not going away any time soon. Meanwhile, Tyco executives said the U.S. Internal Revenue Service is auditing the company's tax filings for 1997 through 2000. They said the audit was "nothing unusual."
Tyco Chairman Edward Breen's restructuring plan and fiery comments to investors in New York City came a day after Tyco cut its profit estimate for this year and fired the head of its fire and security unit because of accounting problems.
Breen said he was "pained" and "disgusted" by the company's latest difficulty.
"The goal for the year is to clean the crap up," Breen said. "If I find anything wrong, heads will roll."
Breen later told a group of journalists that more personnel changes could be coming as Tyco intensifies its audit of its fire and security division. Over the past two weeks, problems have surfaced in the unit's Asian and European operations.
Breen said the fire and security division, which includes ADT security alarms, has the weakest internal controls, by far, within Tyco. Allowances for doubtful accounts, inventory reserves and writing off equipment on canceled accounts were not done properly.
"We clearly missed it," Breen told reporters. Tyco said some of the issues are six years old.
Tyco Chief Financial Officer David FitzPatrick said there are "a lot of itty-bitty companies in fire and security." He also said Tyco's internal audit team is understaffed....
Tyco, which makes everything from duct tape to diapers, said it would scale back its manufacturing facilities to 1,700 from 2,000 by 2006, slashing its manufacturing space by 20 million square feet.
SHARES FALL 12 PERCENT
Tyco shares fell $1.74, or 12.4 percent, to close at $12.29 in Thursday trade on the NYSE. It was the greatest percentage drop in Tyco shares since July.
"The market is really not taking any of the news well," said John Boland, an analyst at NL Capital Management, which owns about 500,000 Tyco shares. "I don't know how comfortable the market is with the radical makeover that's being detailed," Boland said.
To transform Tyco from an acquisition-hungry company to one that emphasizes lean operations, Breen must clean up Tyco's messy accounting and slash manufacturing space that ballooned under previous management.
Total job cut estimates were not immediately available, but Tyco said it expects the plan to save it $1 billion by 2006.
Tyco plans to generate revenue of up to $44 billion in 2006, up from an estimated $38 billion this fiscal year, which ends Sept. 30. Profit is expected to top $4.9 billion in 2006, up from about $3 billion this year.
The company has been embroiled in controversy for more than a year, beginning with a breakup plan engineered and then abandoned by its former chief executive, Dennis Kozlowski. Kozlowski abruptly quit in June and then was charged with evading sales tax on millions of dollars in art purchases. Later, he and three other senior leaders were charged with looting company coffers.
Breen, who took over last year, has been working to overhaul management and restore the company's tattered image with investors.
"Hopefully, there's not a lot of other things there," Breen said, adding that there could be more problems. "We've acted quickly here. We've taken five people out of fire and security during the past few days."
Tyco also found accounting problems in Asia, where four executives were fired.
The revelations came less than three months after Tyco released an internal accounting report by lawyer David Boies that detailed $382 million in errors. No significant fraud was found and the investigation report lifted Tyco's shares.
But the army of accountants and lawyers overseen by Boies apparently did not detect problems at Tyco's fire and security operations in Europe.
$ $ $
October 1, 2002
Probe of Tyco Is Expanded to Include Its Auditor PwC
By MARK MAREMONT and LAURIE P. COHEN, THE WALL STREET JOURNAL
New York prosecutors are investigating whether Tyco International Ltd.'s outside auditor, PricewaterhouseCoopers LLP, knew about secret bonuses paid to former Tyco executives as well as accounting practices that regulators have charged were used to hide the payments, according to people with knowledge of the matter.
Prosecutors have charged Tyco's former chief executive, L. Dennis Kozlowski, and its ex-chief financial officer, Mark H. Swartz, with stealing $170 million in unauthorized compensation and illegally reaping another $430 million from stock sales. In the indictments, prosecutors painted a picture of a company run like a "criminal enterprise," in which top executives paid themselves huge bonuses without board approval and hid the payments from shareholders. Messrs. Kozlowski and Swartz have pleaded not guilty.
Steven Silber, a PricewaterhouseCoopers spokesman, confirmed that the firm was being questioned by the Manhattan district attorney's office about matters relating to Tyco, but said "we have no reason to believe we will be anything but a provider of information for them."
Mr. Silber said the firm couldn't comment on matters relating to Tyco because of "client confidentiality obligations," but he said it is cooperating with Tyco's own internal accounting review and is in the midst of its audit of Tyco's fiscal 2002, which ends Monday.
PricewaterhouseCoopers, which had U.S. revenue of $8.1 billion last year, has served as Tyco's auditor since 1994.
Tyco has hired a separate forensic-accounting firm to conduct a fresh review of its accounting practices since 1999.
TYCO'S TRIBULATIONS
Prosecutors' level of interest in PricewaterhouseCoopers suggests they now may be attempting to make a criminal case against the nation's largest accounting firm, which so far hasn't been ensnared in the widening Tyco scandal. One focus of the probe is whether PricewaterhouseCoopers uncovered the secret bonuses in the course of its audit work, the people with knowledge of the matter said.
These people said prosecutors also are seeking to determine whether PricewaterhouseCoopers was aware of the improper accounting techniques that the Securities and Exchange Commission alleges Tyco used to "bury" the bonus payments.
Some accounting experts who have reviewed a recent Tyco report on its internal investigation, filed with the SEC, say the accounting for the bonuses appears so egregiously wrong that a thorough audit should have caught it.
A related line of investigation by prosecutors is whether PricewaterhouseCoopers auditors were aware that Tyco's annual proxy filings were incorrect but failed to do anything about it. Tyco in recent months has admitted the proxies were wrong, because they didn't include the secret bonus payments in tables laying out compensation for top executives.
Tyco's board has said it wasn't aware of the secret compensation.
Under federal securities laws, auditors have no role in approving proxy filings. But lawyers familiar with New York statutes believe that prosecutors could argue that PricewaterhouseCoopers may have been committing securities fraud by helping Tyco to make incomplete financial disclosures.
Although it is unusual for big accounting firms to be criminally charged, New York has a broad-based law known as the Martin Act that gives prosecutors wide discretion to go after perceived corporate wrongdoers.
Robert Morgenthau, the Manhattan district attorney, declined to comment on whether his office was considering charging PricewaterhouseCoopers. "All I can tell you is that there is a substantial ongoing investigation" of the Tyco case, he said....
Tyco, registered in Bermuda but operating out of offices in Exeter, N.H., is a sprawling conglomerate with annual revenue of about $36 billion. Internal and external investigators have yet to discover any widespread accounting problems at Tyco beyond the secret bonuses. The company also is being investigated by the SEC and the U.S. Attorney's Office in New Hampshire.
In Tyco's recent report on its internal investigation, the company provided fresh details about the accounting treatment used by executives to bury the unauthorized bonuses -- details that may shed light on its accountant's role.
In September 2000, for example, the company said Mr. Kozlowski "caused Tyco to pay a special, unapproved bonus" to 51 employees totaling about $96 million.
Tyco said the bonus was purportedly a reward to employees for helping Tyco reap a $1.76 billion gain from an initial public offering of stock in its optical-fiber unit, TyCom.
Under the plan, which was the largest of the supposedly unauthorized compensation schemes, Tyco forgave previous relocation loans it had extended to the employees and included an extra sum to cover the income taxes on the forgiven loans.
Mr. Kozlowski alone received $33 million, while Mr. Swartz received $16.6 million.
TyCom later turned into a financial debacle as fiber-optic outfits faltered amid a capacity glut. Tyco has since repurchased the stock it sold to the public and written off most of the unit's value.
Typically, accounting experts say, employee bonuses are accounted for as part of general and administrative expenses. But Tyco's filing says the TyCom bonus was booked in three different accounts totaling $97.4 million -- a slightly larger figure than the bonus payments, which Tyco didn't explain. About $44.6 million of the total was booked as part of the TyCom offering expense, which some accounting experts said was incorrect but at least resulted in a similar bottom-line effect as the proper accounting treatment.
The other $52.8 million, however, doesn't appear to have been counted as an expense at all, according to three accounting experts who reviewed Tyco's filing. Instead, Tyco seems to have hidden the sum in two different reserve accounts that had been previously established on the balance sheet for unrelated purposes. The majority of the money, $41 million, was booked against "Accrued Federal Income Tax," the filing says, in effect reducing sums that Tyco had put aside to pay its federal corporate taxes.
"This looks like blatant misstatement of both the income statement and the balance sheet," said Charles Mulford, an accounting professor at Georgia Institute of Technology in Atlanta, who reviewed the Tyco report but isn't involved in the case. Based on the filing, Mr. Mulford said the maneuver appears to have improperly inflated Tyco's pretax income by $52.8 million in the period, the fourth quarter of fiscal 2000. For that quarter, Tyco reported net income of $1.1 billion before the TyCom gain.
Mr. Mulford called dipping into the income-tax kitty particularly "egregious," and said "it would be very surprising if it wasn't picked up by the auditors."
Lynn Turner, a former chief accountant at the Securities and Exchange Commission who also reviewed the filing, went even further, saying "this is called fraud."
As for the auditors, he asked: "How the hell do you do that and not have PricewaterhouseCoopers find it?"...
Relations between Tyco's new management and PricewaterhouseCoopers are at a delicate stage, in part over this issue, according to a person close to Tyco. This person said auditors at PricewaterhouseCoopers had access to information from which they could have known about loan forgiveness.
They would also have been in a position to know that the board was required to approve the related tax-payment portion of the bonuses. Less clear, the person says, is whether it was the auditors' job to seek out members of the Tyco board's compensation committee for further information about the bonus programs.
PricewaterhouseCoopers is also auditor for Dow Jones & Co., publisher of The Wall Street Journal.
Separately, in a bail hearing on Friday, a state-court judge approved the posting of $10 million in cash by Mr. Kozlowski's ex-wife to secure a $100 million bail bond for him, despite the New York prosecutor's objection. However, the judge ruled that "the court is not satisfied" with the 500,000 Tyco shares posted by Mr. Swartz to secure his $50 million bond....
* * *
October 1, 2002
Tyco Woes Creating Problems For Auditor
Reuters - Tyco International Ltd. has become a headache for its outside auditor PricewaterhouseCoopers, whose work is being scrutinized by investigators poring over several controversial deals that happened on the accounting firm's watch.
PricewaterhouseCoopers said Monday that it is cooperating as an "information provider" with the Manhattan district attorney's office on its probe of Tyco. A spokesman for the firm declined to comment on the information requested.
Tyco also confirmed Monday that the conglomerate's accounting treatment of nearly $100 million in secret loans is part of the second phase of an internal investigation led by lawyer David Boies.
One key question for the Boies team is whether audits by PWC uncovered about $96 million in unauthorized payments to a group of employees that included former Chairman L. Dennis Kozlowski.
The Wall Street Journal reported Monday that Manhattan prosecutors are investigating whether the accounting firm knew about the secret bonuses and the methods used to hide them.
The scandal at Tyco is the latest embarrassment for PricewaterhouseCoopers.
In July, the firm agreed to pay $5 million to settle charges brought by the Securities and Exchange Commission that its auditors approved improper accounting and that it violated independence standards. It was the second-largest payment by an accounting firm to the market's top regulator.
During Kozlowski's tenure, Tyco became a lucrative client for PricewaterhouseCoopers, which collected $50.1 million in fees from the conglomerate in 2001.
Before his indictment, Kozlowski also served as chairman of the audit committee at defense contractor Raytheon Co., which paid PricewaterhouseCoopers $84 million in fees in 2001, out of which only $4 million was for audit services.
A senior SEC official said the relationship between Tyco and PricewaterhouseCoopers could merit additional scrutiny from agency investigators....
* * *
October 9, 2002
PwC Auditors Face Charges in Tyco Case
NEW YORK -- New York prosecutors are considering criminal charges against PricewaterhouseCoopers (PwC) auditors who reviewed compensation for the indicted former chief executive of Tyco International Ltd., Bloomberg News reported Wednesday.
Citing people familiar with the situation, Bloomberg reported that Manhattan
District Attorney Robert Morgenthau is examining whether PwC auditors
based in New York and Boston broke the law when they failed to disclose
that a proxy statement didn't include a $33 million bonus paid to then chief
executive L. Dennis Kozlowski. Kozlowski was indicted last month for looting
Tyco....
Bloomberg reported that the district attorney's office is investigating
individual auditors, not the firm, said people familiar with the situation.
Boston-based Rick Scalzo is the lead PwC partner for the firm's Tyco account, according to company filings.
-- NYSSCPA.org News Staff
$ $ $
April 1, 2002
Deconstructing Tyco
So why did Tyco management suddenly decide to break up the conglomerate?
Some say it's the accounting, stupid.
Jennifer Caplan, CFO.com
Prologue:
On Jan. 22, senior management at Tyco International made a startling announcement. In a corporate press release, Tyco executives let it be known that they intend to dramatically alter the structure of the corporation. At the heart of that restructuring: breaking up the company's four operating units into separate businesses, then spinning those businesses off as standalone, publicly traded companies.
In explaining the plan, Tyco CEO L. Dennis Kozlowski seemed to trumpet the virtues of pure-play companies over conglomerates. "Over the past decade, Tyco's share price has increased ten-fold as we have used Tyco's size, access to capital and operating philosophy to build world-class businesses," he noted. "These businesses have now developed to a size and stage where they can thrive on their own and perhaps be even more agile than Tyco."
----------------------------------------------------------------
Kozlowski's explanation would have made sense, too, if Tyco hadn't spent the better part of the Nineties eagerly cobbling together an empire. In fact, it wasn't all that long ago that the Bermuda-based Tyco was being billed as the next General Electric. From 1993 to 2001, the company shelled out a jaw-dropping $64 billion on 200 acquisitions -- a buying spree not seen since the days of John D. Rockefeller, Commodore Vanderbilt, and other men with tall hats. Tyco's long string of purchases covered a wide spectrum of businesses -- from syringe makers to security systems specialists.
Not surprisingly, Tyco management's plan to dismantle the $36-billion-in-revenues conglomerate left many investors and analysts flummoxed. "This drastic change from Tyco is very strange," says Tom Burnett, president of Merger Insight, an affiliate of Wall Street Access. "Tyco management held an analyst meeting only a few months ago when it was extolling the virtues of the combined, diversified enterprise. Now it is completely trashing that concept."
In turn, some Tyco watchers are now trashing the company's explanation as to why it's breaking up its empire. These observers claim Tyco's seismic shift in strategy is more about bookkeeping than agility. They assert that rising investor concerns over financial reporting has made it tough for any acquisitive corporation to wring double-digit earnings growth from aggressive purchase accounting. Says Albert Meyer, a short seller at investment research firm Tice Associates: "Tyco management ran out of help from their accountants."
Swell Cookie Jars
They ran into some bad luck, that's for sure. The downturn in the U.S. economy -- and the cash crunch it triggered -- put a spanner into the works of many deal-making companies. The tightening of the commercial paper marker, for instance, has made it difficult for many corporations to raise short-term capital.
What's more, the unexpected demise of Enron Corp. late last year triggered a national outcry over corporate accounting practices. Many observers insist that aggressive corporate bookkeeping -- often rewarded by investors in the go-go days of the late Nineties -- no longer plays in the post-Enron era. "The days of pushing the envelope are over," says Meyer. "Tyco realized that it just wasn't going to be able to make its numbers without some massaging."
One Tyco watcher goes as far as to say that the company's auditor, PricewaterhouseCoopers, may have suggested the spin-off strategy to Tyco management. A Tyco spokesman denies the assertion. "That is 100 percent false," says Brian McGee, executive vice president at the company. "There was absolutely no pressure or even a suggestion of the sort from our auditors." CEO Kozlowski insists that the company's restructuring plan had been in the works six months before the Jan. 22 announcement. He says the break-up is necessary to unlock shareholder value by as much as 50 percent, help the company pay down more than $11 billion in debt, and allow for more transparent financial reporting.
But given heightened investor sensitivity to earnings guidance -- and revenue restatements, it's not inconceivable that an auditor would advise a client to take a more conservative tack in its bookkeeping (a spokesman at PricewaterhouseCoopers declined to comment for this article, citing client confidentiality). If Tyco senior executives have decided to take a less aggressive approach in their accounting, the move could make it harder for them to meet the company's ambitious revenue targets. Such a likelihood might explain the company's Jan. 22 announcement.
Indeed, Many Tyco critics have long argued that the company manages its earnings by stretching the limits of generally accepted principles of accounting (GAAP). For one thing, these critics maintain that Tyco's finance department uses so-called "purchase accounting liabilities" to keep acquisition-related expenses (severance payments, facility closures, administrative costs, and the like) off the company's income statement.
In accordance with FASB's Emerging Issues Task Force directives, Tyco accrues for purchase accounting liabilities at the time of acquisition, effectively increasing the purchase price and adding the same amount to goodwill. When it incurs these expenses, Tyco credits cash and debits the purchase accounting liabilities, thus keeping expenses off the company's income statement.
Short-seller Meyer argues these purchase accounting liabilities become cookie jar accounts -- accounts which Tyco management can use at its discretion to absorb a variety of operating costs. "GAAP rules allow mainly for the capitalization of professional fees," Meyers argues. "But Tyco management lumps in a host of other expenses that don't make it into the income statement or cash flow numbers."
Of course, Tyco is not alone in its handling of these types of expenses. Edward Ketz, an associate professor of accounting at Penn State's Smeal School of Business, notes that many companies use purchase accounting liabilities to camouflage costs. When a company's operating expenses are hidden in liability accounts, Ketz says it becomes easier for that company to grow earnings consistently. Currently, Tyco is carrying more than $600 million worth of expenses in purchase accounting liabilities on its balance sheet.
But Bob Willens, a tax and accounting specialist at Lehman Brothers, insists that Tyco is playing by the rules. "The accounting they employ is of very longstanding validity," he says. "The EITF [Emerging Issues Task Force] directs that where in connection with an acquisition a restructuring charge is taken, that charge is part of the purchase price for the target company and is therefore part of the goodwill that arose from the acquisition."
Dressing Down the Tarting Up
Even Tyco critic Meyer concedes that Tyco's practices are consistent with GAAP. Nevertheless, he argues that Tyco management often resorts to financial machinations to suit its interests. One example: Meyer claims the company repeatedly lumps operating expenses in with acquisition-related charges, thus hiding costs.
The company also tends to include a lot of one-time or non-recurring charges on financial statements. Disclosures for these special charges in 10-K filings tend to be voluminous and complex. During the 12 quarters ended September 31, Meyer claims Tyco took $2.4 billion in special charges, at an average of $200 million per quarter. Critics say it's much easier for Tyco management to show expanding operating margins by reporting a raft of non-recurring charges. Moreover, a number of Tyco critics claim the company's management makes its deals look better than they actually are. How? By artificially deflating the operating results of an acquisition target in the final weeks before a deal is closed, they charge.
Take the case of Raychem Corp, a maker of power arresters, leak detectors and other electronic devices. Tyco bought the manufacturer for about $3 billion in cash and stock in 1999. In a recent article in the Wall Street Journal, the treasurer at Raychem claimed Tyco executives urged him to speed up bill payments in the months before Raychem was bought.
According to the story, Lars Larsen, then Raychem's treasurer, sent an E-mail to finance department employees at the time of the acquisition. In that message, Larsen reportedly said, "Tyco would like to maximize cash outflow from Raychem before the acquisition closes." Larsem added that Raychem "agreed to do this, even though we will be spending money for no tangible benefit either to Raychem or Tyco."
Tyco's McGee denied Larsen's claims, telling the Journal that the payments discussed in the E-mails were investigated by the SEC in 1999 and 2000 as part of a more comprehensive examination of Tyco's accounting. The commission ended its investigation in mid-2000, however, taking no action against Tyco.
Nevertheless, the Raychem incident is not the first time Tyco has been accused of tarting up deals by speeding up payables and slowing down receivables. "This becomes even easier to do," notes Penn State's Ketz, "when (a company's) acquisitions are not disclosed publicly."
700 Deals Tend to Add Up
Apparently, Tyco does a lot of that. In February, Tyco management acknowledged that it spent about $8 billion over the past three fiscal years on 700 acquisitions -- acquisitions that were never made public. In fiscal 2001, Tyco paid $4.19 billion in cash for unannounced deals, which works out to about 37 percent of the $11.3 billion in cash the company spent on all deals that year.
Tyco does state in its financial filings the "net" amount of cash it pays for acquisitions. Mark Swartz, Tyco's CFO, reportedly said the company doesn't disclose details on its numerous smaller deals because they aren't "material" to a company as big as Tyco. But Swartz has reportedly said that Tyco may include more details about smaller acquisitions in future financial filings.
Others maintain that Tyco management takes advantage of accounting rules by writing down to zero the net asset value of the companies it acquires, thus allowing Tyco to capitalize most of the price it paid as goodwill on the balance sheet. And since the earnings hit from goodwill amortization has now disappeared courtesy of FAS 142, this strategy would seem to be all the more appealing.
"The key question here isn't: 'Is the company's accounting practices illegal,'" notes Whall, "but rather 'Do they mislead investors,'
"The answer in Tyco's case is that they do."
Some of Tyco's owners seem to agree. On February 8, a group of shareholders slapped Tyco with a suit claiming that company management routinely obscures company finances to artificially inflate its stock share price. The suit also alleges that Tyco uses accounting tricks to hide its true financial condition.
But McGee of Tyco dismisses the charges. "If we do everything according to the rules and we disclose everything in a 10-K, then how does that mislead investors?" he asks.
"We are a company that is second to none in the level of disclosure we give."...
-----------------------------------------------------------------
Epilogue:
On June 1, Dennis Kozlowski resigned as chairman and CEO of Tyco International. Reportedly, Kozlowski is under criminal investigation by Manhattan District Attorney's office. The reason for the inquiry? Allegedly, Kozlowski moved hundreds of million of dollars into family trusts and then used those trusts to buy goods and services -- without paying New York state sales tax.
$ $ $
June 18, 2002
Tyco: US conglomerate falls amid revelations of greed and corruption
By Joseph Kay
| Send this link by email | Email the author
The American-based conglomerate Tyco International Ltd. is in deep crisis following a wave of revelations concerning the corrupt practices of the company and its top management.
Dennis Kozlowski has resigned as CEO and Tyco stock has plummeted, threatening the firm with bankruptcy. The collapse of Tyco, one of the world’s largest corporations, with 240,000 employees, would send shockwaves throughout the US and global economy.
In many ways the company exemplifies the current state of American business. Tyco has registered huge profits over the past decade largely by means of acquisitions and financial manipulations. Its booming earnings reports and escalating stock value for much of the past decade were not the products of growing productive capacity, but were instead achieved through accounting tricks and outright fraud.
Given the parasitic character of its economic operations, it quite naturally promoted the most unscrupulous elements into the highest ranks of management.
In these respects, Tyco is hardly unique. A string of corruption scandals has emerged following last year’s collapse of Enron——from the energy industry to telecommunications, from retail chains to Wall Street investment banks——which reveals a systemic growth of corruption and lawlessness that goes to the foundations of American capitalism.
These scandals share certain common features: financial manipulation, accounting fraud, greed and criminality....
A criminal balance sheet and a balance sheet of crime
In May, Manhattan District Attorney Robert Morgenthau opened a criminal investigation into the actions of Kozlowski. The CEO has been accused of using company funds to purchase millions of dollars worth of artwork as well as his $18 million apartment in Manhattan. Apparently, Kozlowski used company “loans” for the purchases, allowing him to avoid paying income tax on the money used. It is unclear that he ever paid back the loans.
Kozlowski is also accused of fraudulently transporting $13 million worth of art to Tyco’s operating headquarters in New Hampshire, in order to avoid more than $1 million in New York state and city sales taxes. Under state law, any purchases for use inside the state are taxable. Rather than pay the $1 million, Kozlowski had the artwork, or, in some cases, empty boxes, sent to New Hampshire, where there is no sales tax. He then had them sent back on the sly to his Manhattan apartment.
Kozlowski has pled not guilty and has been released on $3 million bond. His next hearing is scheduled for June 26. His lawyer is, appropriately enough, Stephen Kaufman, who was the lawyer for financier/felon Michael Milken and hotel magnate/felon Leona Helmsley. New York prosecutors apparently want to make an example of Kozlowski, who, if convicted, could face many years in prison.
Sales tax evasion by the rich, which deprives states of otherwise collectable funds, is a common phenomenon, expected to exceed $20 billion in 2003.
The Manhattan prosecutors are now expanding their investigation to include other company executives, perhaps leading to an indictment of the company itself. Questions are being raised as to whether the firm used its own funds to purchase a house from director Lord Michael Ashcroft and provided interest-free loans to many of its corporate employees.
The Securities Exchange Commission (SEC), in addition to joining with New York in the investigation of tax fraud, has announced it is reopening an investigation into the company’s accounting practices. The original investigation took place in 1999-2000, with the SEC deciding to take no action.
It looked into accounting practices surrounding the company’s many acquisitions. These included a practice known as “spring-loading,” a financial manipulation in which the pre-acquisition earnings of the acquired company are underreported, so as to give the merged company an artificial boost afterwards.
Most members of the company’s board of directors have benefited personally in one way or another as a result of Tyco’s practices. Theoretically, the directors are supposed to be independent of management, including the CEO, so they can objectively oversee the operation of the company.
In practice, this is rarely the case in the American corporation, where directors are closely integrated with management and both sides enrich themselves at the expense of the company and its workers.
In addition to Lord Ashcroft, the board includes Joshua Berman, a lawyer whose law firm was paid as much as $2 million annually by Tyco. Berman’s pay at the law firm was linked to the amount of work he helped bring in from Tyco. Another director recently received a $10 million payment for help in engineering an acquisition. Most of the “independents” on the board are partially paid in the form of stock options, thereby tying their interests to the value of the company’s stock.
The next high-level Tyco executive to go may be the company’s chief financial officer, Mark Swartz, who had close ties to Kozlowski and was a key force in engineering the company’’s acquisitions. Swartz reaped over $170 million in salary and stock options over the past three years.
Also implicated is Tyco’s auditor, Pricewaterhouse Coopers, which signed off on all of the shady accounting practices.
In addition to auditing the company, PwC received millions of dollars for work on computer systems, tax services and other work unrelated to the financial statement audit, presenting conflict of interest problems.
The rise and decline of a corporate behemoth
Tyco’s criminal business practices are rooted in the nature of the company. Its economic activity was not so much production, as acquisition.
In the process of rising from a medium-sized engineering company to a giant conglomerate, Tyco, under the leadership of Kozlowski, absorbed hundreds of companies. Today, the company makes everything from hospital supplies to underwater optical cable and security systems. Kozlowski came to be known as “Deal-a-month Dennis.”
The company’s modus operandi was a modern-day version of slash and burn: acquiring companies and cutting costs by downsizing, in order to inflate short-term revenue.
Last year it made plans to lay off more than 13,000 people and shut down over 240 facilities.
Tyco is not so much a company in the traditional sense of the word, producing a specific commodity or service and making profit on that basis. While Kozlowski dreamt of transforming Tyco into another General Electric, the company resembled more the corporate raiders that first proliferated during the 1980s, using leveraged buyouts to make money through the looting of existing corporations and the workers employed by them.
While the raiders of the 1980s funded their acquisitions through the sale of highly speculative junk bonds (the king of the junk bond market was Milken), Tyco financed its deals primarily through the stock market. Debts from acquisitions could be financed by stock, the price of which would go up following the deal, allowing for further acquisitions. This worked quite well for much of the late 1990s and the early years of this decade, with Tyco stock achieving a 20 percent annual growth rate, making the company a darling of Wall Street.
In the process, however, the company accumulated $27 billion worth of debt.
The objective source of this practice lies in the crisis of the normal process of profit accumulation. Beginning particularly in the 1970s, the rate of profit dropped markedly. Under constant pressure by big investors——banks, hedge funds and the like——to produce high rates of return, companies resorted to the looting of existing social and corporate assets, as well as financial manipulation and speculation.
Because the continuation of Tyco’s business depended above all else on the value of its stock, everything was done to keep it high, including accounting fraud. Illicit practices included “spring-loading” as well as the accumulation of a massive amount of so-called “goodwill.” Goodwill is used to cover the difference between the actual value of an acquired asset and the amount paid for it. It is supposed to represent the potential value that the acquisition will create in the course of the further development of the company.
The process worked something like this: Tyco paid high prices for acquired companies, and rather than writing this cost off as an expense, which would have to be reported to shareholders as a reduction in earnings, the company created a massive amount of goodwill (about $35 billion) on its balance sheet. Since the middle of 2000, Tyco accumulated over $20 billion of goodwill on companies that it acquired for $24 billion. That is, the actual hard assets of these companies were less than $4 billion.
AOL used similar accounting practices to cover its acquisition of Time Warner, and was subsequently forced to write off $54 billion of goodwill, the largest write-off in corporate history.
Tyco could not indefinitely conceal the fact that it was not actually making real profits. The collapse of the stock market over the past two years has undermined the basis of its operations.
The company issued a series of profit warnings early in the year. In the aftermath of the Enron collapse, big investors became more suspicious of “aggressive accounting,” and Tyco was one of the first targets.
Investors were also concerned about what was seen as a blundering management, after a series of reversals linked to a possible breakup of the company. From its peak in January 2001 of $62.80, the stock is now hovering around $13, down about 80 percent on the year.
Its shareholders have lost over <