Tyco Scandal (2002) : (Acc C607-302A Auditing and Good Governance)
Tyco Scandal (2002) : (Acc C607-302A Auditing and Good Governance)
Tyco Scandal (2002) : (Acc C607-302A Auditing and Good Governance)
(2002)
(ACC C607-302A AUDITING AND GOOD GOVERNANCE)
Dumandan, Kenneth R.
Dupaya, Jericho Lorenzo
Encila , Richard jr.
Gabato, Rohany Joy
Galindez, Elizabeth
BSA 301-A
September 30, 2021
Table of Contents
I. Executive Summary
II. Introduction
2.1 Key Decision Criteria
2.2 Rationale
2.3 Corporate Culture of Tyco
III. Body
3.1 Key Issues of Tyco Scandal
3.2 Mechanism of the Key Issues
3.3 Two worst violation in Code of Conduct
3.4 Data Analysis
3.5 Individuals Involved
3.6 Root Cause of Fraud
3.7 Summary in Detection of Scandal
3.8 Results of the Scandal
3.9 Criminal Offenses and Penalties
IV. Recommendation and Conclusion
4.1 Recommendations
4.2 Conclusion
V. References
VI. Appendices
6.1 Table 1.0 Comparative Financial Report Of Operating Income
(Reported Vs Restated, Fr. Yr 1998-2002)
6.2 Table 2.0 Comparative Statement Of Cashflow
(Reported Vs Restated, 2000-2002)
I. Executive Summary
The Tyco Scandal in 2002 was driven by individual greed by CEO Kozlowski and
CFO Mark Swartz who manipulated corporate loan programs in order to get board and
shareholder approval and give themselves unauthorized bonuses. They would then see to it
that the “loans” used to purchase personal expensive expenses would later be forgiven. But
that wasn’t the online crime that the CEO and CFO committed. The two failed to disclose to
investors the sale of a combined 7.5 million shares valued over a 400 million dollars. But
they dis not stop there, two also inflated Tyco’s value by falsifying proxy statements. An
investigation of unpaid sales tax of an expensive artwork Kozlowski purchased using Tyco’s
fund led to the discovery of similar expense and the scheme was finally uncovered. Both of
them were sentence up to 25 years in jail and were forced to pay $235 million dollars
combined restitution and criminal fines. In 2007, Tyco agreed to pay a total of 2.975billion
dollars to settle a lawsuit filed in behalf of the investors.
II. Introduction
Tyco Laboratories needed a substantial restructuring towards the end of the 1960s to
get its new units in line. As Wall Street became disillusioned with high-tech businesses, the
price of company shares had plummeted substantially from its peak in the mid-1960s. In
1969, Tyco sold a number of underperforming businesses and re-evaluated its strategic
strategy. Tyco began its third major acquisition in November 1976 when it bought 13 percent
of the Philadelphia-based process-control designer and manufacturer Leeds & Northrup
Company. Tyco was prevented by a court-approved agreement from gaining more than 19
percent of Leeds & Northrup until March 1978. In January 1978, Tyco gave up its attempt to
acquire Leeds & Northrup, and sold its 19 percent interest to Cutler-Hammer for a $9.2
million profit. In 1982 Gaziano died suddenly at the age of 47. During his decade at the helm,
Tyco Laboratories' sales increased from $34 million to more than $500 million. In 1987
Tyco's sales passed the $1 billion mark. Tyco paid $350 million in 1988 for the Mueller
Company, a 132-year-old water and gas pipe manufacturer. Tyco also boosted its fire
protection sector in 1990 when it paid $642.5 million in cash, shares, and a warrant for
Australia-based Wormald International Limited.
Tyco grew rapidly in the 1990s and early 2000s, with sales rising from $3.07 billion
in 1992 to $34.04 billion in 2001, thanks to an ambitious acquisition spree that saw the
corporation spend an estimated $62 billion buying over 1,000 businesses. However, the
architect of this rise, L. Dennis Kozlowski, left under a cloud in June 2002, and he and Mark
H. Swartz were eventually charged with stealing $600 million from the business and its
stockholders. Tyco struggled to remove the scandal's stain, and was grouped in alongside
companies like Enron Corporation and WorldCom, Inc. as key emblems of the 1990s boom
economy's excesses and greed.
III. Body
The fraud was carried out by the CEO and CFO, who took out loans with extremely
low-interest rates, often disguised as bonuses, that were not approved by the board and never
paid back. Some of these "loans" were given as part of the company's "Key Employee Loan"
program. Tyco's loan forgiveness scheme resulted in up to 40 loans being "forgiven.".
According to an attorney from Manhattan district who’s scrutinizing the case after the
evasion of income tax for some purchases of fine arts, they further found out that $10 million
loans completely forgiven by the corporation while all interest got billed to the company’s
account. And on January 2002, it was also uncovered that the director (Walsh) had received
$10 million transaction for organizing a purchase of CIT group. It's important to keep in mind
that many people were unaware they were doing something unlawful. Money had also been
paid out purchasing their silence about Kozlowski’s actions in the company through the
company programs. As a result, the top branch of Tyco's leadership was further tainted,
allowing Kozlowski to grow bolder over time. Combined, Kozlowski and Swartz had also
sold $430 million worth of company stock without informing investors (lawyershop.com).
Essentially, they concealed their illegal actions by keeping them out of the accounting books
and away from the eyes of shareholders and board members. Although, factors such as their
current organization culture under CEO Kozlowski contributed to this fraudulent action.
Accounting Scandal
Tyco took advantage of the phrase "acquisition" in the financial world and used
accounting flaws to deceive investors. Tyco used a unique path of acquisitions to win the
approval of market watchers with exceptional and incredible financial success. Throughout
that time, it was entirely focused on showing exceptional achievements while ignoring the
weak organic growth it had. It acquired numerous firms and insisted on pursuing that strategy
for a few years, using a cunning gimmick to disguise slow organic development by inflating
the CFFO through acquisitions and disposals accounting methods. Tyco's deception involved
switching between two areas of the cash flow statement: operational and investment cash
flows, specifically the acquisitions accounts. Tyco deceived and carried the outflow through
the investment portion instead of the operational one. This has a favourable impact on the
CFFO, as it shows high quarterly statistics.
Tyco used false accounting methods to exaggerate its profits. It is important to have a
larger number of contracts with new customers in order to increase a company's profitability.
In most cases, a company can do so through its sales department or through dealerships,
which are considered an external network. Tyco, on the other hand, utilized both approaches
but relied primarily on dealerships. Tyco benefitted greatly from a gimmick in which it used
several sales forces from dealers as an outsourced service, therefore not putting them in the
expenses legend as payroll, but as they are selling security contracts. Tyco paid each new
customer contract with an $800 payment. Tyco falsified accounts by classifying these
payments as "acquisition to contracts," which was the major issue in entering them into
financial statements. As a result, in the cash flow statement, this is now an investment
outflow rather than an expense. Doing so would overstate operating cash flow. Tyco, on the
other hand, appeared to enjoy this act and worsened the situation by engaging in yet another
fraud.
This time, Tyco created a new bogus charge that brought millions into the company. It
created a "dealer connection fee," which is a $200 charge made by the dealer for each
contract Tyco purchases. It receives a $200 operational inflow into its cash flow in this
scenario. As a result, the dealers will be irritated since the net profit of a contract will be
reduced to $600 from $800. Tyco, on the other hand, had already considered this and had just
increased the purchase amount to dealers from $800 to $1000.This payment is typically
called “growth bonus.” Also, Tyco immediately recognized the $200 connection fee in its
income statement, while the offsetting $200 growth bonus was amortized over ten years. As a
result, Tyco inflated its operating income by approximately $567 million from its fiscal year
ended September 30, 1998, through its fiscal quarter ended December 31,2002. The $200
connection fee paid by the dealers was wholly offset by the $200 growth bonus that the
dealers received. Accordingly, the $200 connection fee and the offsetting $200 growth bonus
did not alter the economic substance of ADT’s purchase of a security monitoring contract and
should not have been recognized under GAAP. Hence, under the circumstances, they violated
GAAP principle. The scheme also artificially increased Tyco's operating cash flow. From its
fiscal year ended September 30,1998, through its fiscal quarter ended December 31,2002,
Tyco's operating cash flow was overstated by approximately $719 million due to the
accounting treatment given the dealer connection fee. Tyco received no additional cash in the
dealer connection fee transaction, yet it failed to adjust its cash flow from operations to
reflect this reality.
1.) He kept lying to the shareholders by telling them he doesn’t sell his stock. He was
telling this because he wanted the investors to keep pumping money into the company
while he sold his stock. He created a delusion for the investors that he is confident
about the investment. While he was turning around and putting his money elsewhere.
He knew that the share of Tyco will drop its value due to its fraudulent actions.
2.) The other repulsive ethical violation Kozlowski made was his claims of making
donations to charity. He kept begging for lenience grounding on the high numbers of
money he gave to charity while this money was stolen from others. He used these
donations as “tax shield” for his fraudulent operations. His intentions were entirely
unethical and he fooled around with people who trusted him for his own personal
gain.
Based on the table, from year 1998-2002, the cumulative overstated operating income
was about one billion dollars. This is the result of violating the federal securities law by
overstating its reported financial results, smoothing those reported earnings, hiding vast
amounts of senior compensation and a large number of related party transactions from
investors. Just to achieve their desired goal, the company utilized a number of improper
practices conceived, guided, or encouraged by the individuals who managed the company in
leadership of CEO Kozlowski. During the time, at least $500 million of Tyco’s inflated
operating income resulted from improper accounting practices related to some of its
acquisitions. In addition, they used a variety of reserve accounts to enhance and smooth its
reported financial results and to meet earnings projections. Another area of Tyco’s
misconduct involved a scheme designed to overstate operating income and cash flow from
operation in connection with transactions between Tyco’s ADT Security Services, Inc.
(“ADT”) subsidiary and the security alarm dealers from whom it purchased residential and
commercial security alarm monitoring contracts. As a result, given in the data above, the cash
flow from operations has an aggregated overstated amount of $793.8 million from fiscal year
ended 2000-2002.
- Swartz has been freed on a $50,000 bail. The bail is set at $50 million, with 500,000
shares of Swartz's own Tyco stock as bail.
The SEC filed a lawsuit in 2006, charging that Tyco violated federal securities
regulations by participating in a lot of unethical practices. As to the lawsuit, Tyco falsified its
financials by overstating the outcomes through misrepresenting its operating revenue and
increasing it by about $500 million besides misusing acquisition accounting standards. Tyco
also deceived investors by concealing significant party transactions as well as excessive
salary and incentives for top executives.
The company as a whole has suffered extremely. Stock prices had crashed, and those
who were involved had encountered difficulties which included shareholders, employees, and
all stockholders, although not resulted to bankruptcy of Tyco. This impacted investors who
relied on the CEO and CFO's assurances that "they did not sell their shares." When the crime
was discovered, both offenders sold $100 million worth of shares since they knew their
unethical acts would lead their stock prices to go down, and therefore didn't want to invest in
it. When the stock price dropped, all investors suffered losses as a result of the information
provided by the offenders, which led investors to make unwise decisions. The offenders'
actions were not merely "ethically irresponsible," but also "socially irresponsible."As of
2007, Tyco wassplit into three separate companies, consisting of Covidien Ltd. (formerly
Tyco Healthcare), TEConnectivity Ltd. (electronics), and Tyco International Ltd. (formerly
Tyco Fire and Securityand engineering products) (nytimes.com). Each is now a separate
publicly-traded entity.
● Corruption
● 1 count of fourth degree conspiracy
● 12 counts Grand larceny
● 8 counts of first-degree falsifying business records
4.1Recommendations
The main concern in this case of Tyco was a conflict of interest. To avoid the
possibility of having the conflict of interest once again, the company's new management
elected a new board of directors and appointed an independent individual as chairman rather
than a CEO. The company's measures may prove to be effective.In addition, the company
should develop an ethical corporate culture. To accomplish so, the company should establish
a code of conduct. According to the International Labour Organization, a code of conduct is a
corporate declaration that explains ethical principles and applications that employees should
follow. A code of conduct might encourage ethical and moral behaviour among corporate
personnel. Employees might avoid convicting in a conflict of interest if they followed the
code of conduct. Employees should be given the guidelines to the code of conduct so that
they may better understand it.
Aside from the code of conduct, the company should also provide seminars and
training for workers to educate them how to deal with issues related to conflict of interest,
such as the issues that have been mentioned, which include stealing money funds, accounting
fraud, abuse of power, and so on. During training and seminars, employees should be
encouraged to practice whistleblowing when it comes to directly protecting your organization
from wrongdoings like fraud and misbehaviour. While encouraging whistleblowing, the
company should also put in place safeguards for whistle-blowers to protect them from being
boycotted by their co-workers. The protections provided may also allow the whistle-blower
to report the wrongdoing of others without intimidation. Keeping the information of the
whistle blower confidential is an example of the protection that the corporation may provide.
The mere possibility of fraud might be minimized if there was a culture of whistleblowing.
Leadership has a significant impact on company culture. Top management should
lead with integrity so that their subordinates may look up to them as a positive role model. It
is critical for leaders to establish the proper leadership in order to inspire ethical behavior
among employees. A responsible and honest leader can aid in the promotion and transmission
of his or her ethical and moral values to subordinates. As a result, while hiring a new
manager or promoting an existing manager, the firm should examine and stress not just the
person's skills, but also his or her personality and ethical viewpoint.
4.2Conclusion
Every company will face such ethical difficulties at some point, and the ethical
questions will be raised. The majority of Tyco International's ethical concerns revolved
around conflicts of interest. Stealing millions of funds, abuse of power, and accounting fraud
were all concerns related to conflict of interest Apart from the conflictof interestviewpoint, all
of these situations were immoral in other ways.
The company has suffered largely as a result of top management's inappropriate use
of power to engage in unethical behaviour.Due to a lack of a strong ethical environment and
absence of ethical leadership, Tyco suffered significant losses during the 2002 scandal. If a
firm seeks to survive and grow in today's business world, it needs to be more than just aware
of ethical standards, it needs to be actively implementing them, combined with rigorous
internal controls to prevent unethical or unlawful behaviour. A company's corporate
governance structure must be protected against unethical practices. In the absence of such
safeguards, Tyco executives committed theft, dishonesty, and accounting fraud.
Consequently, these measures not only affected the company's employees and stockholders,
but it also had an uneven effect on people who owned Tyco shares in their employer-
sponsored retirement account. This effect has caused a delay in retirement in causing it in
certain cases.
V. References
2021.
Kennedy, Kristin A. “An Analysis of Fraud: Causes, Prevention, and Notable Cases.”
n. pag. Print.
VII. Appendices
Increase (decrease) in operating (loss) income 126.6 (570.4) (276.4) (205.4) (64.1)
Operating (loss) income, as restated $ (1,452.4) $5,616.4 $5,198.0 $ 1,985.4 $ 1,884.0
Operating Margins:
As previously reported (4.4) % 18.2% 18.9% 9.7% 10.2%
As restated (4.1) 16.5 18.0 8.8 9.9
TABLE 2.0 COMPARATIVE STATEMENT OF CASHFLOW
(REPORTED VS RESTATED, 2000-2002)
This table shows the amounts ($ in million) that are reported and restated from year 2000-
2002.
Purchase of property, plant and equipment (1,708.7) (1,678.8) (1,797.5) (1,773.4) (1,703.8) (1,695.9)
Construction in progress - Tyco Global Network (1,146.0) (1,146.0) (2,247.7) (2,247.7) (111.1) (111.1)
Acquisition of businesses, net of cash acquired (1,683.8) (1,683.8) (9,962.0) (9,962.0) (3,746.4) (3,746.4)
Acquisition of customer accounts (ADT dealer
(1,401.0) (1,139.3) (994.6) (798.1) (500.10 (390.7)
program) (1)
Other Investing activities 6,298.1 6,286.5 3,363.2 3,378.9 (876.1) (874.8)
Net cash provided by (used in) investing
activities 358.6 638.6 (11,638.6) (11,402.3) (6,937.5) (6,818.9)
Net cash (used in) provided in financing
activities (1,836.8) (1,836.8) 6,295.7 6,295.7 1,165.3 1,165.3
Net increase (decrease) in cash and cash
equivalents 5,680.2 5,678.2) 1,322.4 1,323.3 (497.2) (497.2)
Tyco capitals cash and cash equivalents
- -
transferred to discontinued operations (1,272.6) (1,272.6) (808.0) (808.0)
Cash and Cash equivalents at beginning of
period 1,779.2 1,780.1 1,264.8 1,264.8 1,762.0 1,762.0
Cash and Cash equivalents at end of period $ 6,186.8 $ 6,185.7 $ 1,779.2 $ 1,780.1 $ 1,264.8 $1,264.8