Tyco International Ltd. (NYSE: TYC) is a diversified manufacturing conglomerate incorporated in Bermuda, with United States operational headquarters in Princeton, New Jersey (Tyco International (US) Inc.). Tyco International is composed of five major business segments:
- ADT Worldwide,
- Fire Protection Services,
- Safety Products,
- Flow Control and Electrical
- Metal Products.
The Kozlowski era.
Dennis Kozlowski joined Tyco in 1975 and succeeded John F. Fort as CEO in 1992. In 1993 Tyco changed its name to Tyco International Ltd. The 1993 fiscal year saw the company post net income of a mere $1 million. After 1993 the business picked up dramatically and from 1994 to 2002, Kozlowksi built Tyco into a global conglomerate with $36 billion in revenue from the sale of everything from diapers to fire alarms.
Through acquisitions and mergers Tyco spent over $60 billion and acquired 200 major corporations and hundreds of smaller companies. Kozlowksi was notorious for being a very fast paced acquisitor, earning him the nickname "Deal-a-Day Dennis . Targets had to be complementary to an existing Tyco operation, however subtle that synergy might be. Tyco’s management was completely decentralized. Provided that they met their ambitious profit goals, Kozlowski’s executives could run their divisions as entrepreneurs. The strictly-by-the-numbers management--tended to antagonize the top executives of acquired companies, most of which Tyco radically shrank to boost cash flow immediately.
Kozlowski became notorious for his extravagant lifestyle, supported by the booming stock market of the late 1990s and early 2000s. Allegedly, he had Tyco pay for his $30 million New York City apartment which included $6,000 shower curtains. Kozlowski also purchased several acres in the private gated community, "The Sanctuary", in Boca Raton, Florida.
The collapse of Enron Corporation in 2001 was a wakeup call for investors. Like Enron, Tyco had a complex accounting structure due to its myriad of acquisitions. In January 2002, Kozlowski announced a temporary stop to acquisitions and presented a radical plan to boost shareholder value. Tyco was to be split into four separate publicly traded companies. This would make the corporate structure more transparent and would boost shareholder value. Investors reacted with skepticism. Three months later, Kozlowski shifted course again claiming that he would only sell off one subsidiary, CIT Group, through an IPO.
CIT Group had been bought in 2001 after a suggestion of Tyco board member Frank E. Walsh Jr., who was friendly with Albert R. Gamper Jr., CIT's CEO. Kozlowski had paid Walsh, fellow Seton Hall alum, a $20 million reward “fee” for the deal. The divestment of CIT ultimately brought Tyco a $7 billion loss.
By May 2002, Tyco's stock was trading at less than $20 per share, down 66 percent since the beginning of the year. The firm's market capitalization, which in December 2001 had been higher than that of General Motors Corporation, Ford Motor Company, and DaimlerChrysler AG combined, had plummeted by about $80 billion.
The accusations.
As far back as December, 1999, the SEC had investigated Tyco's handling of some 120 acquisitions. The following summer, however the agency had sent a letter informing Tyco that it was not taking action. It wouldn’t be accounting fraud that brought Tyco’s glamorous CEO down. In June 2002, Manhattan District Attorney Robert M. Morgenthau brought charges against Kozlowski on two accounts. It was evasion of New York sales tax on the purchase of expensive artwork, not his manipulations at Tyco that forced him to resign as CEO of Tyco International. One day after his resignation, Kozlowski was indicted. On November 27, 2002, the State of New Jersey took separate action in the scandal, filing a federal suit against Tyco and former personnel, with charges in part of violating the New Jersey RICO statute. As a result of the scandal, Tyco and some former directors and officers were named as defendants in more than two dozen securities class-action lawsuits. That March 31, Tyco made a motion to dismiss, which was granted in part over a year later, on October 14, 2004. At the end of 2002, U.S. News & World Report picked Kozlowski as its corporate rogue of the year, choosing him over Enron and WorldCom executives involved in much more extensive corruption. On September 19, 2004 Kozlowski and Tyco’s former CFO Mark Swartz were finally sentenced to eight and one-third to 25 years in prison .
Executive behavior.
What could have made a man who wanted to be a combination of Jack Welch and Warren Buffet turn into a greedy defrauding manipulator? Like any crime, the reason was a combination of reward, opportunity and a slim chance to be caught.
Kozlowksi was never one of the handsome fast boys like the traders and executives at Enron. He has frequently described himself as the son of a Newark cop turned police detective. Kozlowski was so keen to advance at Tyco that he started taking night classes at Rivier College, a Catholic college in Nashua. He completed only three classes, though he claimed to have earned an MBA from Rivier in a questionnaire submitted for the 1988-89 edition of Who's Who in America . For most of the 27 years that Kozlowski worked at Tyco, he was an exceptionally enterprising and effective manager.
In the early 1990, the success of the stock market had created the notorious “Bubble Era” that would end with the great dot com crash of 2001 . Not to be outdone by the upcoming “new world” companies, the traditional industry started a merger and acquisition spree of unprecedented scale. The phrase "Get large or get lost" was the wisdom of the day. Companies that knew how to grow where awarded with large boosts in share price. The CEO’s that brought about this new wealth were lavishly awarded. The growth caused ever higher shareholder expectations which in turn put the pressure on companies to produce ever higher results. The lack of corporate governance combined with their status as superstars caused many CEO’s to actually behave like superstars. Delusions of grandeur had previously been reserved for heads of state but in the corporate kingdoms of the late 20th century, the CEO’s felt increasingly above the law. According to Tyco, Kozlowski misappropriated $43 million in corporate funds to make philanthropic contributions in his own name, including $5 million to Seton Hall, which named its new business-school building Kozlowski Hall. This is behavior is not unlike that of a Roman emperor or an African dictator.
According to the indictment, Kozlowski's thievery escalated after Tyco shifted 40 more employees from Exeter to Boca Raton, where ADT had a luxurious office. Like Enron, Tyco had cultivated a corporate culture where executives felt entitled to the company’s assets. This attitude is further demonstrated by statements made during the Tyco trial where Kozlowski and Swartz testified that they had no intention of deceiving anyone and that they were entitled to the payments as bonuses under the company's board-approved compensation formulas.
Kozlowki’s apparent success, his status and ambition caused increasingly erratic behavior. Apart from his private spendings, financed by the firm, he allowed himself to become influenced by flamboyant men, like Lord Michael Ashcroft. Ashcroft was founder and CEO of ADT, a security and motoring auctions group. As drab as Kozlowski’s pre-CEO life had been, so exciting was Lord Ashcroft’s lifestyle. ADT was set up in Bermuda and Ashcroft used his yacht, the Atlantic Goose as a floating office. The acquisition of ADT was structured as a reverse takeover, allowing Tyco to move its statutory headquarters to the tax haven. Ashcroft joined the board of Tyco as one of the few executives of acquired companies. This was the first step in creating a network of offshore subsidiaries to shelter foreign earnings from U.S. taxes. It would be financial constructions like this that would ultimately bring down Enron.
Board oversight.
As long as Tyco’s profits soared, the investors couldn’t get enough of “Dennis the Menace”. The board of directors, normally installed to oversee the behavior and results of the executives on behalf of the shareholders, let Kozlowski do whatever he pleased. This wasn’t very different from the situation at Enron, Worldcom and other high rolling companies. Tyco’s SEC filings show no significant challenges to Kozlowksy’s reign in that period.
From 1997 through 2001, Tyco's revenues rose by 48.7% a year, five times faster than General Electric's, while its pretax operating margins improved to 22.1%, easily topping GE's 16.4%. It was easy for Kozlowksi to argue that he deserved a higher salary then Jack Welch, the CEO of GE, who was the best paid executive at that time.
The board of directors was only sparsely informed about Tyco’s executive decisions. The acquisition of CIT Group, which cost the company $9.2 billion wasn’t relayed to the board until 6 months later when Swartz mentioned it in a rough draft of a proxy statement. The $20 million fee that Walsh had received for the deal stunned the board members. When the board challenged him, Kozlowski claimed that he had made an innocent mistake--but at least had talked Walsh down from the $40 million he had initially wanted. Walsh refused to give the money back and left the board. Tyco sued Walsh and brought in the lawyer David Boies and his firm to start turning over every rock. Walsh declined to comment.
During the Tyco trial, prosecutors showed that Kozlowski and Swartz used company tax and relocation loan programs to make personal investments, buy jewelry and art and live ``like royalty.'' They were accused of awarding themselves and others $137 million in unauthorized payments in the form of cash, Tyco stock and company loan forgiveness.
The executives forgave their own debts without getting proper approval from the compensation committee of Tyco's board. Tyco’s executives were also charged with misleading investors about the company's financial condition while selling $575 million in Tyco shares and options. All of which the board of directors apparently never knew about. According to the other board members, Director Philip Hampton, who died in 2001, was aware of some of the payments. This statement drew comments from Assistant District Attorney Ann Donnelly who said it was “despicable to use a dead man's testimony as a defense”.
In the pre-SOX era, the independence of outside board members was questionable. Relationships with accounting firms were so tight that, in case of the Enron scandal, the auditors where often in on the scheme or at least closed their eyes to any irregularities. The increasingly complicated structure made it very difficult for board members who weren’t accountants to know exactly what was going on.
Why did the board disregard reporting rules?
In the Bubble Era, shareholder value was the most important factor. As long as companies provided growth, other stakeholder priorities were effectively bypassed. Unlike Enron, there was no whistleblower that brought the case to light. The lack of compliance to reporting rules wasn’t confined to Tyco. Former Chairman of the SEC Arthur Levitt pointed out, “the spate of (…) corporate failures and scandals of the past few years could not have occurred without the widespread breakdown in the oversight system of American corporate markets . Too many corporate professionals, including officers, directors, analysts, investment bankers, and most notably the accountants and attorneys, appeared to have forgotten that their fiduciary duties require them to represent the interests of the corporation and the shareholders first, above all other interests, including their own”. The culture of 'what can we get away with' eroded public confidence in American financial markets.
Until the passage of the Sarbanes-Oxley Act of 2002 both the accounting and the legal professions were allowed to set their own ethics rules with little or no oversight by the government. Official oversight results by professional auditors were therefore often kept confidential. This caused a “see no evil, hear no evil” attitude in many boards, because no board member wanted to be accused of being a “spoil sport” when the going was good.
How to regain trust?
In 2002, Tyco agreed to replace all board members who served with Kozlowksy, notably one of them being Michael Ashcroft. The move came after investors and a New Hampshire regulator objected to a bid to keep two of the board members . It was a good step in the direction of regaining investor confidence. Sarbanes-Oxley establishes new or enhanced standards for all U.S. public company boards, management, and public accounting firms. The act contains a minimum standard which Tyco needs to improve upon. There are several points that Tyco can take into consideration.
Direct measures:
1. Transparent corporate structure.
The complex acquisition schemes of the late 20th century caused a great many board members to lose oversight. Only a professional accountant or lawyer would be able to make sense of the great many links, special purpose vehicles and other specialized structures. Board members are often chosen because of their standing and past expertise, not for their current knowledge. The simpler the company structure, the easier it is to follow for board members and shareholders.
2. Truly independent board members.
Sarbanes-Oxley requires a greater number of outside board members. Individual board members should be able to acquire outside advice and be accountable for any decisions they make. Board members should be able to challenge executive decisions before they are made.
3. More influence of stakeholders.
Financial stakeholders should be engaged in (potential) management issues. Even in the SOX era, stakeholders are often informed after a decision has been made. A good example of this is ABN AMRO’s sale of LaSalle to Bank of America. This deal was made over the weekend without informing the shareholders. The decision was held up in court but only because ABN AMRO was to be sold anyway.
4. Direct influence on reward structure.
SOX requires executive compensation to be published. This doesn’t guarantee any influence over the board’s executive compensation policy. Fortis Bank’s CEO, Jean-Paul Votron has been ousted because his salary was raised 73% while at the same time Fortis chose not to pay dividend and to issue emergency stock. This was done after the decision and only because shareholders revolted. It will undoubtedly result in a golden parachute for the former CEO.
In the long term, Tyco should create and stimulate a corporate culture where the interest of all stakeholders comes first. A workers council, like that required by law in The Netherlands should be able to challenge management decisions. Shareholders need to get more direct influence on important company decisions and long term strategy. Other stakeholder groups should be engaged in the dialogue.
Periodical reporting could be replaced by a balanced scorecard or dashboard structure. In the information age it’s much easier to provide up to date information to stakeholders without losing a competitive edge.
Resources.
To enhance a company’s reputation there are principles to adhere to:
- Publish what you preach. The internet is a good medium to tell the world what your company is up to.
- Practice what you preach. Show in actions what the board tends to do about stakeholder issues. The media are an important source to show and tell.
- Be accountable. Board members and executives should be held accountable for their actions. This doesn’t mean blamestorming but each decision should be defendable. If not, the board member or executive needs to go.
- Training. One of the most important resources to get a good reputation is training of staff and board. If you know about SOX requirements it becomes a lot harder to say that you weren’t aware when there are issues to deal with.
