Taking Down the Lion: The Rise and Fall of Tyco's Dennis Kozlowski (9 page)

When he testified in court about the David Tice fiasco, McGee was asked if, when he was head of investor relations at Tyco, he observed short-sellers doing anything to drive down the company’s stock price. “Yes, I did experience that,” he responded. McGee said that short-sellers did “ . . . everything from calling up our sell side analysts and . . . giving them information that was false about the company. They would call up reporters and try to feed stories with false information about the company. They might publish reports like Mr. Tice did or go on television and make comments about the company which were negative and which were false.” McGee said that within a week of watching the market react negatively to what Tyco knew to be completely baseless accusations levied by Tice, Kozlowski wanted to speak directly with Tyco shareholders about the “malicious and unfounded rumors that were in the marketplace concerning Tyco.” McGee recalled discussing ways to address the rumors and said, “Dennis’s decision was that the quickest and best way for us to address what was going on in the market was talk to our shareholders directly and provide them with the company’s view of, that the company fundamentally had not changed at all and there should be no concern with respect to Tyco stock or the company itself.” So that’s what Kozlowski did. He spoke to shareholders directly using scheduled conference calls during which he assured shareholders and other interested parties that the company’s accounting methods were solid.
14

Even though Tyco addressed them quickly and directly, Tice’s allegations didn’t die easily. Adding insult to injury, the Securities and Exchange Commission (SEC) launched an investigation into Tyco’s acquisition accounting methods because of the market’s costly reaction to Tice’s report. On the day Tyco voluntarily announced the SEC investigation in December of 2001, the price of Tyco stock fell 23 percent. When the SEC decided to investigate Tice’s claims, Kozlowski made the public statement that “[i]n light of the recent market activity in our stock, which is not justified by any development at the company, we welcome the opportunity to respond to this request. We remain confident of our accounting methodology, our public disclosures and the continuing strength of our business.” The SEC wanted to review all supporting documents related to acquisition charges and reserves for the preceding six years. During that time period, Tyco had made more than 120 acquisitions.
15

In December of 1999, Dennis Kozlowski must have been pleased that he hired Mark Belnick as Tyco’s Chief Corporate Counsel in 1998, just a year before the company had to address the shit storm started by David Tice. Belnick, who oversaw the SEC investigation, had been with Tyco for less than sixteen months when the investigation began.

Belnick was exactly the kind of lawyer a company would want in its corner to deal with a serious regulatory investigation. Along with degrees from Cornell and Columbia, Belnick had an impressive background and an unblemished reputation.
16
Just prior to joining Tyco, he was a senior partner at Paul, Weiss, Rifkind, Wharton & Garrison, one of the most respected law firms in New York. In 1987, Belnick served as Deputy Chief Counsel to the U.S. Senate during the Iran-Contra Hearings. He served as Chief Counsel to the National Association of Securities Dealers (NASD) Select Committee in 1995 and played a role in reorganizing the NASD and Nasdaq.

Belnick’s former colleagues at Paul Weiss held him in high esteem, both before and after he left the firm to join Tyco. They continued to hold Belnick in high esteem when he was indicted and tried for serious felonies by the Manhattan DA—charges related to his compensation at Tyco. On most days of Belnick’s criminal trial in 2004, many Paul Weiss attorneys were in the courtroom in support of their former colleague. Just after he was acquitted by a Manhattan jury in the summer of 2004, a former colleague said of Belnick’s character that he was a man who “wouldn’t even go near the line.” Mark Belnick indeed seemed to be a by-the-book straight shooter, a veritable Boy Scout; his sterling reputation was an asset to Tyco when the company addressed the SEC’s concerns.
17

At the front end of the investigation, Belnick went to Kozlowski and voiced the need to use outside counsel to assist in the probe. Belnick said Kozlowski’s response was definitive: “Yes. Hire them.” Belnick brought in William McLucas, the former head of SEC enforcement. If there was something shady buried in Tyco’s acquisition accounting, McLucas would find it.
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With McLucas in tow, Tyco began producing documents to the SEC—tens of thousands of documents. Belnick said Kozlowski instructed him to cooperate fully with “no resistance. We need to give them everything. We need a clean bill of health.” During Belnick’s criminal trial in 2004, Mark Foley, former Tyco Senior Vice President of Finance, testified that when the investigation was announced, Belnick’s instructions to the finance department were to be “open and honest” with those conducting the investigation. Foley said Tyco turned over more than 400 boxes of documents to the SEC.
19

Early in the investigation, Belnick made an unexpected strategic decision: Tyco would offer up CFO Mark Swartz and head of finance Mark Foley and allow the SEC to question them directly. Tyco would allow the regulators to ask anything they wanted to know about the company’s accounting methods. Kozlowski said it was actually Josh Berman who first suggested that Swartz and Foley open themselves up to SEC questioning. It was a high-risk plan to which the CEO agreed. But what if Swartz or Foley stumbled? What would happen if SEC investigators didn’t hear what they wanted to hear? It was a gutsy decision, but Belnick, Kozlowski, Berman, Swartz, and Foley, on behalf of Tyco, had nothing to hide and they wanted SEC
investigators to know they had access to anything they wanted—everything they needed to resolve questions about Tyco’s acquisition accounting. William McLucas described the decision to offer up Swartz and Foley as “the right combination of street smarts, balls, integrity, judgment, and lunacy.”
20

During the months the company was under investigation and despite the blow to Tyco’s stock price, the company continued to thrive. On March 20, 2000, Tyco was included on
Businessweek
’s list of the “50 Best Performers.” On April 18, 2000, Tyco announced its second-quarter earnings—a 47 percent increase in earnings per share. The company announced on May 7, 2000 its agreement to acquire the Electronic OEM Business of Thomas & Betts for $750 million in cash, and on June 28, 2000, Tyco announced the planned $4.2 billion acquisition of global healthcare giant Mallinckrodt.
21

Midsummer, the SEC officially closed its investigation of Tyco. On July 13, 2000, seven months after it began its probe, the SEC issued a “closing letter” and took no action against Tyco. Kozlowski recalled that there was a nonmaterial restatement of earnings the result of which bumped up earnings per share by one cent in a prior period. Beyond that, the SEC reported no problems after thoroughly combing through the books and records of Tyco International. It was very good news for Tyco, its shareholders, the trinity of Marks (Belnick, Swartz, and Foley), and a huge relief for CEO Dennis Kozlowski.
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In an interview after his acquittal in 2004, Belnick said he welcomed the pressure of the 1999–2000 SEC inquiry. “This is going to sound bizarre,” Belnick said, “but during the SEC investigation, working night and day, I enjoyed working at Tyco.” He explained, “I was working to save the company, and I hate to say that’s enjoyable, but that’s what I do.” After the SEC probe ended favorably, Belnick and Foley each received a bonus for their work during the investigation. Kozlowski was consistent—the bonuses were pay for outstanding performance. Some of the charges for which Belnick was later indicted, tried, and acquitted involved the bonus he received for his contribution to the successful resolution of the SEC investigation. When asked during Belnick’s trial about the bonuses he and Tyco’s Chief Corporate Counsel received, Mark Foley testified that the bonuses were recorded in the company’s books and records and “reflected as all other normal operating bonuses.”
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* * *

Years after Tice’s allegations and the SEC investigation had been laid to rest, another short-seller questioned and criticized as too aggressive Tyco’s acquisition accounting methods. James Chanos of Kynikos Associates alleged that Tyco “spring-loaded” acquisitions. “Spring-loading” is a process used to make an acquired company appear less financially healthy at the time of acquisition—on the day the deal closes. In order to spring-load, the acquired company accelerates payment of expenses (at
the instruction of the acquirer) during the weeks preceding the closing, writing off bad receivables, writing down inventories, and taking any other steps that will make the company appear less financially healthy at the time of closing. Spring-loading benefits the acquirer by making an acquired company’s performance appear to improve immediately after the deal closes. Cash flow looks better, earnings improve, and because of the timing, the financial turnaround is attributed to the restructuring, cost-cutting measures, and revenue enhancements implemented by the acquirer. Like restructuring reserves, spring-loading techniques were not, in and of themselves, illegal or a violation of accounting standards in effect at the time, but could become a professional and legal concern if spring-loading resulted in misleading financial statements.

The spring-loading allegations were fueled by email messages provided to
Fortune
magazine by a few employees of Raychem, a Tyco acquisition that closed not long before Chanos raised concerns. The emails suggested that Tyco instructed Raychem to pay expenses early, before they were due, and before the acquisition was completed. Of note, Raychem employees wore black armbands to protest Tyco’s acquisition of the company
before
the acquisition closed and
before
allegations of accounting improprieties were emailed to the magazine.

In response to
Fortune
’s questions about spring-loading, Brad McGee again staunchly defended Tyco’s accounting methods, stating adamantly that “we do not manipulate earnings and cash flow at the business so we can get some kind of positive benefit after the acquisitions.” McGee also referenced the SEC investigation and closing letter. How could there still be questions about whether Tyco’s acquisition accounting was too aggressive or misleading? McGee explained that “there is a very rigorous set of checks that we have internally, where every adjustment must get Tyco corporate approval and approval by our auditors.”
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During the entire decade Kozlowski was CEO, Tyco’s independent auditor was PricewaterhouseCoopers (PwC), one of the “Big Four” accounting firms with the prestige, reputation, and hourly rates of top notch auditors. During Kozlowski’s first criminal trial, his lead defense attorney Stephen Kaufman explained during opening statements how vital the opinions rendered by PwC were to his client. Kaufman asked the jury: “[Do] you know what outside auditors do for a company? They’re giving you the Good Housekeeping Seal, they want to see if everything is kosher.” Kozlowski said he and his top management team regularly sat down with the company’s auditors and asked for details about Tyco’s accounting methods. “Every quarter I asked them to rate Tyco on a scale from 1 to 5,” Kozlowski recalled, “with 1 being the most conservative accounting methods they saw among the companies they audited and 5 being the most aggressive. They told me consistently that we were right in the middle—which is where you want to be. That’s where I wanted us to be.” Kozlowski said he placed great weight on the outcomes of audits and the opinions of PwC. “They were highly skilled auditors and a reputable firm and we
paid them tens of millions of dollars to do their job,” he said. “I believed they would find problems if they existed. I counted on it.”
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* * *

A year and a half after David Tice’s allegations were quashed by the SEC’s lengthy and vindicative investigation,
Institutional Investor
magazine asked Dennis Kozlowski: “What do you think of when you hear David Tice’s name?” Kozlowski’s responded: “I think he’s a short-seller who saw an opportunity to go after a company with a high multiple, who made up some stuff and made us into one of the more scrutinized companies in the world.”
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Eight

The Good Old Days

“I wish there was a way to know you’re in the good old days before you’ve actually left them.”

Andy Bernard,
The Office
1

Not many people know how it feels to be on top of the world. For a while, Dennis Kozlowski knew what it was like.

The Retention Agreement

The company grew and prospered during the first few years of Kozlowski’s leadership, but Dennis Kozlowski and Tyco International really hit their stride in the late 1990s. In 1996, Tyco was added to the Standard & Poor’s (S&P) 500, a stock market index of the 500 largest U.S. companies based on market capitalization.
2
During his criminal trial, Kozlowski was questioned about Tyco and asked if it was a large company during the years he was the CEO. Kozlowski told the court and the jury that Tyco was large “by virtually any measure, sales or market capitalization, Tyco usually fell within the top 25 companies in the world in the last few years that I was running [the company].”
3
In 1998, Kozlowski was courted by Raytheon Company, a Massachusetts-based high tech company that, like Tyco, operated in four business segments: commercial and defense electronics, engineering and construction, aviation, and major appliances. The company’s Board wanted Dennis Kozlowski to serve as its next CEO.

Kozlowski was elected to the Raytheon Board of Directors in June of 1995, so the Raytheon Directors knew him well and had no doubt watched and were impressed by Tyco’s success and phenomenal growth over the three years Kozlowski sat with them in the Raytheon boardroom.
4
Kozlowski was tempted to take the reins of what was at the time one of the largest defense contractors in
the world with annual revenue of nearly $20 billion; when the job was proffered in 1998, Raytheon was substantially larger than Tyco.
5
Kozlowski ultimately declined the offer, even though he could likely have negotiated compensation as CEO of Raytheon even more lucrative than the compensation opportunities he had with Tyco.

Raytheon was not the only company interested in luring Dennis Kozlowski away from Tyco in the late 1990s and early 2000s.
6
As his tenure at the head of the flourishing diversified conglomerate neared the ten year mark, Kozlowski was in demand. Despite occasional problems that ranged from serious to simply annoying, like the SEC investigation, David Tice, and a journalist Kozlowski thought had a grudge against Tyco, the company’s performance under his leadership made Kozlowski a darling of executive headhunters. Even with frequent and serious external interest, Kozlowski was a Tyco loyalist. Over the years, he received many attractive offers to go elsewhere, but he always opted to stay with Tyco.

By the end of calendar year 2000, Kozlowski was weighing his options and he seriously considered embarking on a new endeavor; he planned to leave Tyco for the world of private equity.
7
He considered joining the Carlyle Group in Washington, DC, but was leaning more toward building his own private investment firm. Before 2001, Kozlowski had not signed an employment contract with Tyco. He and Mark Swartz were both at-will employees. Because of Tyco’s strong performance and the enormous performance-based compensation Kozlowski received during the prior few years, there was concern on the Street that Kozlowski would pocket his earnings and move on to other pastures. The Board of Directors thought the time was right to secure an employment contract with their CEO; the Directors wanted an agreement that would offer investors and the Board assurance that Kozlowski would remain CEO of Tyco for many years into the future.

If the terms of a contract tell tales, the Retention Agreement the Tyco Board of Directors entered into with Dennis Kozlowski in January of 2001 shouted that the Board wanted very much for Kozlowski to remain Tyco’s chief executive and was willing to pay whatever it took to keep him. Kozlowski said, “Mark [Swartz] worked with the Board to draft the agreement. I didn’t work on the draft, but I believe it was derived from Jack Welch’s compensation as disclosed in GE’s proxy.” The Board, on Tyco’s behalf, entered into a Retention Agreement with Dennis Kozlowski the pecuniary value of which was so great that Kozlowski himself was shocked at the Compensation Committee’s willingness to sign it.

Under the terms of the agreement, “in recognition of [Kozlowski’s] significant contribution to the creation of shareholder value and leadership during his tenure as Chairman of the Board of Directors, President and Chief Executive Officer of the Company, [the Compensation Committee] wishes to obtain his commitment to serve as Chairman of the Board, President and Chief Executive Officer of the Company until his 62nd birthday on November 16, 2008 and his commitment to
serve after his retirement as a consultant to the Company, at the direction of the then Chief Executive Officer of the Company.”
8

Upon his exit from the company, Kozlowski would receive “an amount equal to three times the sum of (x) [his] then current annual base salary (without giving effect to any reduction thereof following the Effective Date [of the agreement]) plus (y) the highest annual bonus (including cash, shares and other forms of consideration) earned by [Kozlowski] with respect to the eight fiscal years preceding the year in which the Date of Termination occurs (or an amount equal to the annual bonus including cash, shares and other forms of consideration earned by [Kozlowski] with respect to the Company’s 2000 fiscal year, if higher).”
9

(x) + (y) = $412,480,272, considering the floor of the agreement, which was Kozlowski’s compensation in 2000. According to Tyco, Kozlowski’s compensation during the years leading up to the Retention Agreement was as follows:

1997 $26,454,603

1998 $70,329,840

1999 $21,074,097

2000 $137,493,424
10

In addition to the $412.5 million golden parachute, Kozlowski was granted 800,000 restricted shares of Tyco common stock on January 21, 2001, the day he signed the Retention Agreement. Each year for the following eight years on the anniversary date of the agreement, one-eighth (1/8) of the restricted shares would vest; if Kozlowski stayed with Tyco until his sixty-second birthday, all 800,000 shares would be fully vested.
11
On the day members of the Compensation Committee and Kozlowski signed the Retention Agreement, Tyco stock (TYC) closed at $84.85.
12
If the stock performed similarly over the next eight years, Kozlowski’s 800,000 shares would be worth more than $67.9 million.

On top of the $412.5 million golden parachute and the 800,000 shares of TYC stock, Kozlowski would be paid one thirty-sixth (1/36) of the (x) + (y) amount each year for the rest of his life in exchange for thirty days of consulting services per year.
13
The Compensation Committee valued Dennis Kozlowski’s consulting services to be worth at least $11,457,785 a year ($412,480,272
×
1/36). That’s $381,926 per day of consulting work (($412,480,272
×
1/36) / 30). If a consulting day was eight hours long, Kozlowski’s hourly rate would have been $47,740. Those numbers are based on Kozlowski’s compensation in FY 2000. If Tyco performed better than in FY 2000 during any year before his birthday in 2008, the dollar amounts would have been even larger.

In addition, Kozlowski was to receive all fringe benefits available to him on the day he left the company or retired “including but not limited to relocation benefits [did the Tyco Board believe he would need to relocate in order to provide 30 days of
consulting services per year?], security, sponsorships and events, grossed-up payments for New York state and city taxes, if applicable, health insurance coverage (including coverage for spouse (or domestic partner)), life insurance coverage and continued access to Company facilities and services, including access to Company aircraft, cars, office (with secretarial and administrative support), apartments and financial planning (tax, accounting and legal) services.”
14

Of course, the Compensation Committee had to draw the line somewhere. The generous and expensive benefits remained in effect only until Kozlowski’s death.

In exchange for the $412.5 million, the 800,000 shares of stock, consulting fees, and what must be the most generous benefits ever offered to a former employee by a business organization, Dennis Kozlowski had to forego other opportunities available to him and agree to serve as CEO and Chairman of the Board of Tyco International Ltd. until November 16, 2008. At Phil Hampton’s house in Naples, Florida on January 21, 2001, Compensation Committee members Phil Hampton, Stephen Foss, James Pasman, and Peter Slusser signed the Retention Agreement. As did Dennis Kozlowski.
15

The Board of Directors and the members of the Compensation Committee must have felt absolute certainty and confidence in their CEO in order to offer such a rich contract. Even in the much-maligned world of executive compensation, Tyco’s Retention Agreement with Dennis Kozlowski was extraordinary. Imagine how embarrassing it would be if, after entering the agreement, the company’s performance faltered. Envision the extreme public scrutiny the Tyco Board would face: the criticism of shareholders, journalists, analysts—of everyone. The Directors would no doubt be sued, accused of breaching their duty to Tyco shareholders when they entered into the half-billion-dollar-plus employment contract. The agreement was so outrageous, the Directors may have been accused of criminal negligence. After the Compensation Committee signed the Retention Agreement on January 21, 2001, if Tyco did not continue on the same trajectory of growth and performance it experienced over the prior nine years under Kozlowski’s leadership, the Tyco Board of Directors was screwed.

There was, however, one provision in the agreement that gave the Board a way out of performing everything promised in the contract. Under the terms of the Retention Agreement, if Kozlowski was terminated “with Cause,” the company would have no further obligation to him.
16
“Cause” was defined as Dennis Kozlowski’s “conviction of a felony that is material and demonstrably injurious to the Company or any of its subsidiaries or affiliates, monetarily or otherwise.”

The Recession of 2001

Almost immediately after the Retention Agreement was signed, a recession hit the U.S. economy and ended the longest period of economic growth in history. Despite
the downturn that began in the first quarter of 2001, Tyco continued to grow, perform, and acquire as had become expected. In February of 2001, the company announced a $400 million addition to its fire and securities services group with the acquisition of Scott Technologies, a designer and manufacturer of respiratory systems and other devices for the firefighting and aviation markets. Scott Technologies had projected annual revenue of around $250 million.
17

On March 28, 2001, more good news came when
Businessweek
magazine named Tyco the number one performing company of 2000. The article noted that “[w]ith a bear market in full cry, uncertainty about the economy rampant, and much of Corporate America deep in hunker-down mode, Dennis Kozlowski might be expected to be a tad less ebullient. But the supremely self-assured chief executive at Tyco International Ltd. (TYC), who masterminded $9 billion worth of acquisitions last year and then stunned analysts in March by announcing he would spend another $9 billion to buy commercial-finance giant CIT Group (CIT), looks on the carnage as a call to action.” The article quoted Kozlowski as saying: “This is a good environment for Tyco . . . [t]here will be more opportunities than there were when the economy was booming.” Of Kozlowski’s ability to lead Tyco through the recession, the article said that “ . . . after helping build the conglomerate from a $20 million-a-year corporate also-ran into a $30 billion-a-year industrial giant, Kozlowski knows how to navigate rough waters.” Tyco landed at the top of the list of best performing companies because of its stellar results.
Businessweek
noted that Tyco shareholders had benefited from Kozlowski’s “go-get-’em” style and shared that “[i]n the past three years, the company’s stock has returned 117%, including a 44% return in the past year alone, while Tyco’s earnings on a latest-12-months basis have climbed 149%, to $4.8 billion, as sales rose 27%, to $30.3 billion.”
18

On April 27, 2001, Tyco was ranked number one in the “2001
Reuters
Survey of U.S. Larger Companies;” the rankings were derived from data collected from analysts about the quality of information companies make available to them. Kozlowski said of the Reuters top spot, “Tyco is delighted to receive top marks in the prestigious 2001
Reuters
Survey of U.S. Larger Companies. Having just reported that Tyco’s second-quarter earnings per share rose 30%, it is especially gratifying to know that analysts have ranked Tyco first for plain talk.” The 407 broker-analysts who responded to the survey ranked Tyco as the company with the best transparency, quality of reporting, and disclosure.
19

The Wedding

Dennis Kozlowski’s professional life had never been better. The company continued to perform despite the recession and both he and Tyco had become favorites of analysts and of the media. On May 28, 2001, Kozlowski appeared on the cover of
Businessweek,
tagged “The Most Aggressive CEO.” The accompanying story lauded
Kozlowski for leading Tyco through the economic downturn; in the worst quarter for U.S. corporate profits in ten years, Tyco’s earnings grew 33 percent and the company reported a 26 percent increase in sales. Kozlowski spoke of Tyco’s recently announced plans to acquire The CIT Group, Inc., at the time the largest independent commercial finance company in the United States. It would be a $9.2 billion acquisition and seemed to break Kozlowski’s rule against acquiring companies outside of Tyco’s existing business divisions. Filled with his typical and seemingly unsinkable confidence, Kozlowski said, “I think CIT will be one of the best deals we’ve ever done.”