Essay Instructions: Based upon the fact pattern below, prepare a memorandum for the Board of Directors of a company to explain your proposed response to the allegations in the fact pattern. While the facts may (in the real world) implicate actual laws or regulations.
Your division of a large company offers service contracts for homeowners pursuant to which your service department provides two annual service calls per year to check and provide routine service for the homeowner’s household appliances (refrigerator, air conditioner, etc). The service contracts provide that hoses, filters and other ‘routine maintenance items’ will be provided at cost. The annual service contract costs $800.00.
The contracts also provide that customers who pay by check will get a 10% “early pay discount” which will apply to the subsequent, renewal contract.
Your company has been in business for four years and has about 12,000 contracts, many of which have been renewed annually.
A few weeks ago, a customer account representative came to you (the compliance officer) with the following issue: He received a phone call from the surviving son of a homeowner, recently deceased, who was wrapping up the parent’s financial affairs. The son had called to ask whether the company refunds money for mid-year cancellations, and was told, per company policy that there are no partial refunds after 120 days into the calendar year.
However, in reviewing the account history of the deceased homeowner, the customer representative realized that the homeowner has NOT received the correct “early pay discount” for the prior two years, and had therefore been overcharged. The customer account rep then spot checked other account records and found that some renewal contracts had been properly discounted, while other had not.
As the customer representative told you, “Some of our reps seem to know about our early pay discount policy, while other does not.”
You have been at the company for only one year (as division compliance officer), and the prior compliance officer’s records are in disarray. It appears that there has never been a compliance assurance review of contract charges. Since the division which handles homeowners’ service contracts is quite small (compared to other company operations, neither the outside neither accounting firm nor the internal auditors had conduct year-end reviews of the division’s records.
You have checked the procedure manual for account representatives, and confirmed that the early pay discount procedure is properly discussed. IT has informed you, however, that the company’s computer bookkeeping system does not automatically credit renewals where there has been an earlier payment for cash. The system in use requires a manual entry to carry the earlier payment forward.
You have asked the president to call a meeting of the Board to enable you to brief the members about this issue. At this time, you are working with the financial department have the people there prepare either a manual or computer method to determine the extent of the overcharges. The president has told you to not go forward with any proposed review until after the Board presentation.
Your memorandum to the Board should not assume that this practice was either negligent or intentional, since you have no facts on this issue yet. You also have no idea how much may be owed to customers, or whether the company needs to repay overcharges with interest, etc. You have decided to begin the memorandum with a general discussion of the company’s compliance plan, etc.
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Essay Instructions: Assignment:
Prepare a 6 (exposition) page double-spaced research paper that addresses what specific corporations or non-profit organizations have done to activate the Board to actually overseeing and acting upon ethical dilemmas that have faced the firm (or organization). Limit your discussion to a comparison of two organizations. That is, analyze what things that the Board of each organization has done to actually take the ethical oversight responsibilities seriously.
There are several approaches that one could take in developing this paper. First, I would advise that you read about the Sarbanes-Oxley Legislation that was passed by Congress in 2002. Even a brief perusal of this legislation will give you some idea of the new internal review and control standards that are legally required of organizations.
Secondly, I would suggest using key words such as "Board of Directors AND ethical" in your term searches (in ProQuest, LexusNexis, Social Science Index, and in Google, for instance). Other key words might be:
? Ethical Responsibilities and Governance
? Corporate Ethical Programs
? Ethical Programs and Non-Profit
You will find that many corporations and non-profit organizations have taken dramatic steps to increase ethical awareness. Your focus should be on the Board of Directors or Board of Governors. An operative question might be: "What roles have Boards (directors or governors) now assumed in the wake of the many crises of the past four years?" In doing so, you will find that some boards have made serious changes, while others have made minor changes. Make a comparison of two organizations and their boards (either successful change compared to successful change or successful change compared to limited change). Assess the need for the change in each circumstance, and the apparent benefits of the changes.
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Essay Instructions: Summarize the overall viewpoint of the author, and discuss the major issues presented in the case.
Review the Questions for Thought. Answer these three questions using the business ethics principles.
1. What do you think Kozlowski?s motivation for trying to avoid sales taxes on his art purchases was? Explain.
2. Explain the concept of commingling assets with respect to the Tyco case.
3. Would it have been possible for the board of directors to see the adjustments taking place in the many different programs at Tyco? Explain.
TYCO: IM SURE THAT ITS A REALLY NICE SHOWER CURTAIN
THE RISE OF DENNIS KOZLOWSKI
On May 18, 2002, Tyco CEO Dennis Kozlowski, who had received his degree in accounting and finance from Seton Hall University in 1968, gave the commencement address to St. Ansell?s College in Manchester, New Hampshire. He talked about the difficult decisions that the graduates would have to address during their lifetime. He stated that the graduates would have questions that would test their moral standards. He told the students that the questions would get tougher and the potential consequences would be more severe, so his advice was to do not the easy thing, but the right thing. Less than two weeks later, on June 1, 2002, Dennis Kozlowski, who had worked at Tyco since 1975, announced to the board of directors for Tyco International that he was the subject of a criminal investigation in New York for evasion of sales taxes on a painting he had purchased in Manhattan. The board of directors demanded that he step down as CEO of Tyco, and he did on June 3, 2002. Tyco told the media that Kozlowski had resigned for personal reasons. By resigning and not being fired, Kozlowski was no longer eligible for a severance package that was valued at approximately $ 120 million. Previous Tyco CEO John Fort took over as interim CEO. Fort, Tyco?s CEO from 1982 to 1992, had stopped using the company jet and sold off the president?s house and other corporate- held apartments during his first reign. In an ironic example of dj vu, Fort, who was on the board of directors of Tyco, had to ad-dress the same issues in 2002 that he dealt with in 1982.
THE FINANCIAL TROUBLES BEGIN
It was not a pleasant time for Tyco because it had lost $ 86 billion in market capitalization because of concerns investors had about the company?s strategic focus. In addition,
a number of critics were complaining about the compensation levels given to Kozlowski and other members of Tyco?s management. Tyco's stock had fallen from $ 60 in December 2001 to $ 16.05 inDecem-ber2001to$16.05 in June 2002. In addition, Tyco had accumulated $ 27 billion in debt through various acquisitions. Kozlowski was called Deal a Month Dennis for his aggressive acquisition style. He said his goal was to create the new General Electric. Some of the major acquisitions are shown in Table 1. In his ten years as CEO, through growth via acquisition, Kozlowski grew the size of Tyco from $ 2 billion when he took over the CEO position to create a conglomerate with annual sales of $ 36 billion at the end of fiscal 2001. Tyco had a quarter of a million employees worldwide and had a market capitalization of $ 120 billion. At the time of his resignation, Kozlowski had exercised $ 240 million in stock options and had been paid close to $ 100 million over the previous three years. The estimated tax that Kozlowski avoided on the painting was $ 1 million. In addition, Kozlowski owned residences in New York, New Hampshire, Florida, and Nantucket Island. His New York apartment was reportedly bought for $ 18.5 million in 2000. His distaste for paying taxes led him to move the corporate headquarters to Bermuda from Exeter, New Hampshire, in 1997 to reduce Tyco?s tax liability to 20 percent, which is approximately half of the average corporate rate for United States based firms.
PAYING FOR EMPTY CRATES
It was alleged that Kozlowski had bought approximately $ 15 million worth of paintings in New York and had the art gallery ship them to New Hampshire to avoid paying the 8.25 percent New York State and Manhattan combined sales tax even though they were to be hung in his Fifth Avenue apartment.
On June 4, 2002, Kozlowski was indicted by a grand jury for tax evasion for avoiding paying more than $ 1 million in taxes on six paintings that he had purchased in the fall of 2001. In addition, he was also charged with tampering with evidence and willfully falsifying financial records. He was ordered to surrender his passport and was released on a million bond. One piece of evidence that prosecutors were able to obtain was a fax that listed the paintings Kozlowski had purchased, which were supposed to be shipped to New Hampshire, with the words wink, wink in parentheses. Kozlowski had bought approximately twelve paintings including a Renoir and a Monet that were valued at more than $ 15 million from August to December 2001. Karen Kozlowski, Dennis?s wife, worked with art director Christine Berry to help purchase the art for their Fifth Avenue apartment. Some of the paintings would be sent to the apartment to see how they would look on the wall before they were purchased. In December 2001 the Kozlowski?s purchased a Monet for close to $ 4 million from a private Manhattan dealer. The art dealer, Alexander Apsis, did not charge sales tax on the painting because Kozlowski gave him a written document that stated that the painting was going to be shipped to New Hampshire. However, the painting went to the Manhattan apartment, which is less than two blocks from the art dealer?s office. During the same time period, the Kozlowski?s purchased four additional paintings that were valued at close to $ 9 million and included a Renoir. For those purchases, Kozlowski told the art dealer to ship empty boxes to New Hampshire to represent the shipment of the paintings. On January 2, 2002, five empty boxes were shipped to New Hampshire and signed for by a Tyco employee.
THE INVESTIGATION EXPANDS
On June 6, 2002, prosecutors announced that the investigation had been expanded to include an examination to see whether Kozlowski used Tyco funds to finance the maintenance of his Florida homes as well as paying for other personal expenses. The investigation started to focus on whose money was used to purchase the artwork that was hanging in Kozlowski?s Fifth Avenue apartment. In addition, it appeared that Tyco money was used to purchase the $ 18.5 million apartment in Manhattan for the Kozlowski?s. The investigation also examined whether Tyco money was used to purchase the Kozlowski home in Boca Raton, Florida. The Boca Raton home had been owned by Lord Michael Ashcroft, who became a Tyco board member in 1997 when Tyco purchased ADT, which Ashcroft?s company owned. In October 1997 Ashcroft sold his house to his wife for $ 100. She sold it the same day for $ 2.5 million to a Tyco vice president, Byron Kalogerou. The investigation was to determine whether the home was purchased with Tyco funds and Kalogerous name was put on the title to avoid having the appearance that Tyco bought the home for Kozlowski from a Tyco board member. By June 9, 2002, Tyco?s stock had fallen from a high of more than $ 60 in December 2001 to $ 10.10, resulting in a reduction of market capitalization of approximately $ 95 billion.
On June 26, 2002, Dennis Kozlowski was indicted on two additional charges of tampering with evidence in the tax evasion case. The new indictment was based on the disclosure that Kozlowski had physically taken a bill of lading from the Tyco offices in Boca Raton that had falsified the shipment of the paintings from New York to New Hampshire before the files were sent to the New York district attorney?s office in May 2002. As with all the previous charges, Kozlowski pleaded not guilty to the new felony charges. On July 23, 2002, Tyco reported a third- quarter loss of $ 2.32 billion, com-pared with a net profit of $ 1.18 billion for the third quarter of 2001. On July 25, 2002, Tyco announced that it had hired Motorola?s president, Edward Breen, as the new CEO and chairman of the board. Breen had also previously been the CEO of General Instrument Corporation, which was acquired by Motorola in 2000.
On September 12, 2002, Dennis Kozlowski and CFO Mark Swartz were indicted for illegally obtaining hundreds of millions from Tyco for their own use. It was alleged that the two former Tyco executives were involved in racketeering by being involved in stock fraud, the disbursement of bonuses that were not authorized to employees, and the falsification of expense accounts. It was also alleged in the indictment that Kozlowski and Swartz paid off a Tyco board member and other employees to keep their fraudulent activities quiet. The prosecutors accused Kozlowski and Swartz of running a criminal enterprise, which is commonly used when indictments are applied to members of organized crime. The Manhattan district attorney?s office claimed that the two former Tyco executives started the covert fraudulent operation in 1995. The DAs office alleged that the two men had spent millions of Tyco?s dollars for their personal use. It was also alleged that the two Tyco executives would control the focus of Tyco?s internal audits and would file disclosure reports with the SEC without any input from the legal department to avoid any chance that their activities would be discovered. The prosecutors calculated that Kozlowski and Swartz had stolen $ 170 million directly from the company and had illegally gained another $ 430 million by selling Tyco stock while the price was artificially high due to financial statement manipulations. The prosecutors also alleged that Kozlowski had defrauded the company by giving himself and other Tyco employee?s unauthorized bonuses and loans that were not repaid to the company. It was alleged that Kozlowski used a Tyco program designed to help executives pay taxes on stock options to improperly borrow an estimated $ 242 million for his own use. Kozlowski used the money to purchase paintings, real estate, yachts, and jewelry for himself and his wife. Swartz allegedly used the same program to borrow $ 72 million for his personal investments. In addition, Kozlowski and Swartz used $ 78 million in loans from Tyco?s real estate relocation pro-gram, which was designed to help pay the costs of employees who were being transferred to the Boca Raton office from the New Hampshire office. The money was used by the two executives to purchase real estate and other personal expenses.
THE PAYMENT OF EXPENSES
On September 18, 2002, it was revealed that Dennis Kozlowski had approved without authorization the forgiveness of loans to fifty- one Tyco employees in the amount of $ 95 million in return for their silence. The company also released the results of an internal review headed by David Boies, who found that Tyco paid for personal expenses of Kozlowski including an $ 80,000 payment to American Express, a traveling toilet box that cost $ 17,100, an umbrella stand designed to look like a dog for $ 15,000, a sewing basket that cost $ 6,300, a $ 6,000 shower curtain, two sets of bed sheets that cost $ 5,960, a set of coat hangers that cost Tyco $ 2,900, a metal wastebasket that cost $ 2,200, a $ 1,650 notebook, and a pincushion that cost $ 445.
Tyco filed a lawsuit against Kozlowski, requiring the former CEO to return to Tyco his compensation and benefits since 1997 and the forfeiture of all of the components of his severance package.
HAPPY BIRTHDAY, KAREN!
One of the allegations was that Tyco paid $ 1.5 million of the $ 2.1 million total cost of the fortieth birthday party for Kozlowski?s second wife, Karen, at Island Sardinia in Italy. Kozlowski had met Karen when she was working as a waitress in a New Hampshire restaurant near Tyco?s U. S. headquarters. A memo given to The Wall Street Journal gave the details of the $ 2.1 million party. It was described as a Roman Empire theme with Kozlowski being the emperor. The party included gladiators, exotic animals, and an ice sculpture of Michelangelo?s David that disbursed Vodka through its genitals. Not to be outdone, there was also a woman- shaped birthday cake that had an exploding bosom when sparklers were inserted in the cake. The servers were dressed in togas with an open bar for the seventy- five guests and more than twenty- five staff members. Elvis appeared on a huge screen apologizing for not being able to appear in person, and an extravagant light show ended the evening. Jimmy Buffett also performed for a fee of $ 250,000. The guests did not to pay for anything, including flying over to Italy. The birthday week was so elaborate that a logo was made and it was included on bags, hats, and other gifts given to the guests. Also part of the week- long events were a scavenger hunt, horseback riding, water skiing, and trips on Kozlowski?s yacht. After the party was over, Karen and some of the guests took a Tyco jet and flew to Florence to participate in a cooking class. The only guidance Kozlowski gave the planners was not to do anything that he would be embarrassed to see on the front page of The Wall Street Journal. In Tyco?s 2001 annual report, which was published after the birthday celebration, Kozlowski informed Tyco investors that the company had a continuous drive to reduce costs throughout the organization. Kozlowski described the party as primarily a business function. At the retrial of the two executives, Mark Foley, who was the former senior vice president of finance, testified that the party was going to be a management meeting and would include a meeting with the board of directors.
MARK SWARTZ, CFO
Chief financial officer Mark Swartz was more involved in the deal making for the acquisitions than the financial statements of Tyco. He was considered the prot?g? for Kozlowski. From 1999 to 2002, Swartz received more than $ 170 million, which included a salary of $ 48 million and $ 125 million in stock options. His compensation was one of the highest for a CFO during that time period. Tyco?s new CEO, Edward Breen, asked Swartz to leave Tyco on August 1, 2002. In agreeing to step down as CFO, Swartz gave up his previous severance package, which was estimated to be worth $ 100 million, and settled for $ 9 million and other retirement benefits when Breen threatened to challenge the previous severance agreement in court. On September 11, 2002, David FitzPatick was hired by Tyco as the new CFO. He was previously a CFO and senior vice president for United Technologies Corporation. On February 19, 2003, Mark Swartz was indicted for tax evasion for not paying federal in-come taxes on a loan of $ 12.5 million that was given to him in 1999. The tax due for the bonus would have been close to $ 5 million. On April 1, 2003, Tyco filed a lawsuit against Swartz, asking for more than $ 400 million in money that Swartz had taken that had belonged to Tyco. The lawsuit was filed after Swartz refused to resolve the issue with arbitration. In September 2004 Mark Swartz?s Manhattan apartment near Central Park was sold by Tyco for $ 12 million. Swartz, using Tyco funds, bought the apartment in 2002 for $ 15.274 million.
On January 27, 2005, the retrial for Kozlowski and Swartz started in New York. During his retrial Swartz stated that he did not remember checking his 1999 W- 2 form to see whether he had reported the Tyco forgiveness loan of $ 12.5 million. The former accountant testified in court that he only remembered seeing the W- 2 two years later in the summer of 2002.
MARK BELNICK, TYCO LEGAL COUNSEL
On June 11, 2002, Tyco fired its general legal counsel, Mark Belnick, over disputed circumstances. Belnick, who had been at Tyco since 1998, stated that he was fired be-cause he lost a power struggle with one of Tyco?s board members, Joshua Berman, and the lawyer who was hired in April 2002 to be included in the Tyco corporate governance committee, David Boies. On the other hand, Tyco stated that the reason Belnick was fired was he was disrupting the internal investigation by having Tyco pay for executive?s personal expenses as well as issuing previously undisclosed loans to Tyco executives. Joshua Berman also became part of the investigation when it was discovered that Tyco was paying his law firm up to $ 2 million annually and Berman?s compensation until 2000 was tied, in part, to how much business he could bring to the law firm from Tyco. Belnick had complained that Tyco was depending too much on Berman?s law firm of Kramer Levin Naftalis & Frankel for its legal needs. Boies had stated that Belnick had been given $ 20 million in compensation without the payment being disclosed to the board. Belnick?s lawyer confirmed the payment of $ 20 million but stated that the proper disclosures had been made. The Securities and Exchange Commission required that the compensation for the five top- paid officers be disclosed. It was assumed that Belnick?s compensation would have put him in the top five, yet Tyco did not disclose this information to the SEC in its filings.
In addition, initial results of the internal investigation done by Boies?s firm, Boies, Schiller & Flexner LLP, raised questions as to whether Tyco money was used to buy Belnick?s residences in New York City and in Park City, Utah, without full approval by the board of directors. On June 17, 2002, Tyco filed a lawsuit against Mark Belnick that alleged that Belnick had accepted payments of $ 35 million from 1998 to 2001 without disclosing it to the compensation committee of the board of directors or to the SEC. In addition, the lawsuit also claimed that Belnick purposely deleted files relevant to the investigation on June 10, 2002, which was the day he was fired. On September 12, 2002, the Manhattan district attorney?s office announced that Belnick was criminally charged with defrauding Tyco. It was alleged that Belnick hid the fact he received a relocation loan from Tyco that he used to buy a resort home in Utah. The district attorney?s office claimed that Kozlowski paid off Belnick with the loan so Belnick would not say anything about the internal transactions that were occurring at Tyco.
On February 3, 2003, Mark Belnick was indicted for three more criminal charges, including obtaining a $ 12 million bonus that was not authorized. The three charges were grand larceny, fraud, and falsifying documents. During his trial, prosecutors claimed that Belnick did not disclose $ 14.9 million in company relocation loans that were used to purchase an apartment in New York and a home in Utah. Belnick was listed as the only Tyco employee in Utah. Belnick was accused of taking up to $ 32 million through loans and bonuses without proper authorization. After a two-month trial in which the jury deliberated for five days, Belnick was found not guilty on all charges. On May 2, 2006, Belnick agreed to pay the SEC a $ 100,000 penalty as part of the settlement for civil fraud charges. In addition, Belnick agreed not to serve as a corporate officer of a publicly traded company for five years.
TYCOS BOARD OF DIRECTORS
On June 13, 2002, it was also announced that the board of directors at Tyco was investigating the actions of interim CEO and board member John Fort for conflict- of-interest violations. Fort was an investor and advisor for DLJ Merchant Banking Partners II, which bought Tyco?s flow- control products division for $ 810 million in August 1999. Fort did not disclose this information to the board of directors at Tyco. In addition, it was alleged that Fort had sold a Rye, New Hampshire, house to Kozlowski in 1996, which was paid for with Tyco funds. Furthermore, another Tyco board member, Stephen Foss, had a business relationship with the leasing of an air-plane to Tyco. The lack of control by Tyco?s board of directors pertaining to the decision- making process by the top executives at Tyco is evident by examining the compensation levels given to Kozlowski and Swartz from 1998 to 2001 as shown in Table 2. While their salaries ranged from more than $ 1 million to $ 4 million per year, the issuing of stock bonuses and options ballooned the total compensation package for the two top Tyco executives combined to close to half a billion dollars for the four years.
On October 22, 2002, it was revealed that Kozlowski had a close financial relationship with another board member, Richard Bodman. Bodman had been a Tyco board member since 1992, and Kozlowski had invested $ 5 million into a private stock fund that was managed by Bodman. Bodman was a member of Tyco?s oversight board committees audit, corporate governance, and nominating. Bodman?s close relationship with Kozlowski did not hinder his opinion of a $ 20 million payment made to another board member, Frank Walsh. Bodman called the payment made without board approval corrupt and a complete violation of the responsibilities given to the board of directors by the investors.
On June 17, 2002, it was announced that former independent board member Frank Walsh, Jr., created a conflict of interest by taking a secret $ 20 million from Kozlowski for helping Tyco buy CIT Group. The fee was not disclosed when it took place, but six months later Tyco disclosed the fee, and it resulted in a decrease of $ 16.7 billion in market capitalization of Tyco stock. On December 17, 2002, Frank Walsh pleaded guilty to securities fraud. Walsh admitted that he had taken a payment of $ 20 million for helping Tyco acquire CIT Group, but he did not disclose that information
to any other members of the board of directors. In exchange for not being sentenced to jail, Walsh agreed to pay back the $ 20 million with an additional $ 2.5 million as a fine for his actions. The $ 20 million finder?s fee was given to Walsh so Tyco could buy CIT Group, which was owned by Walsh?s friend Albert Gamper, Jr. Tyco bought CIT for $ 9.2 billion and sold it in 2002 for a loss of $ 7 billion. In the first criminal trial against Kozlowski, evidence was presented that showed Kozlowski had admitted to Fort in a January 2002 phone conversation that the $ 20 million payment was a mistake and it was an action that should have been done only with board approval. Fort testified at the trial that board members usually arranged potential acquisitions with-out any additional compensation. Fort told Kozlowski that the payment would have been denied by the board if the board had been aware of the deal.
THE WONDERFUL WORLD OF TYCO ACCOUNTING
On June 13, 2002, the SEC announced that it was starting an investigation of Tyco based on its accounting procedures. The SEC wanted to determine whether Tyco was using its reserve accounts to artificially increase its level of profitability after a number of acquisitions by the conglomerate. The investigation was a reopening of an investigation the SEC had started in 1999 and finished in 2000 after Tyco had acquired more than 120 companies in six years during the 1990s. There were questions pertaining to the $ 3 billion in restructuring charges that Tyco realized after the acquisitions took place. The 1999 SEC investigation took place when Albert Meyer, from the firm David W. Tice, raised concerns about how Tyco was using aggressive accounting methods during its acquisition splurge. The internal audit to examine the books for Tyco took 25 lawyers, 100 accountants, and 65,000 hours to review the financial trans-actions of more than 45 Tyco operating units. On December 30, 2002, Tyco admit-ted that it had artificially inflated profits for years and would have to eliminate the $ 382 million in profits that had previously been reported by the company. The five-month internal investigation revealed that Tyco had a corporate culture that encouraged managers to bypass accounting rules to inflate the results of their department?s performances. One department memo stated that the employees for one of the Tyco divisions had to try to reduce costs through the process of financial engineering. Another division stated that the employees had to create stores to validate the ac-counting changes that occurred, which increased the level of profitability of the division. The internal audit also discovered that Tyco would force companies that it was acquiring to report lower performance numbers so when Tyco took over the company, it could present a dramatic increase in financial performance. The investigation also found that there was poor documentation of transactions, the policies and procedures in place to control for fraud were not adequate, and there were inadequate procedures for authorizations of employee?s actions. Some examples of improper authorizations included employees having company cars and also receiving car allowances and having a $ 150,000 charitable contribution given to an organization that was not a charity. By April 2003, Tyco had estimated that it had an additional $ 1.2 billion in accounting problems that had to be restated. This announcement came after two announcements in March in which Tyco had estimated restatement of its financial statements of $ 265 million and $ 325 million. From October 2002 to August 2003, Tyco had to revise or restate its financial statements on five separate occasions with the net result being a reduction of $ 2 billion in pretax profits from Tyco?s previous financial statements from 1998.
KEY EMPLOYEE LOAN PROGRAM
In 1983 then- CEO John Fort established the Key Employee Loan Program as a way in which top executives could borrow money from Tyco to pay for taxes on their stock options. The premise behind the program was that Tyco did not want the executives to be forced to sell shares in Tyco stock to pay the taxes when they exercised their stock options. The purpose of the program was to pay taxes only on stock options, and that was explicitly stated in Tyco?s 1995 proxy statement. Tyco?s former treasurer, Barbara Miller, testified in the first trial that in 1997 the scope of the program moved beyond loans for tax payments. Tyco?s former CFO, Swartz, told Miller that executives could now borrow money for any reason with the only restriction being that the total amount borrowed must not surpass a calculated percentage of the executive?s restricted stock holding based on the executive?s tax rate. As a result, Kozlowski and Swartz borrowed Tyco money through this program to buy real estate, jewelry, and other personal items. One of the charges was that Kozlowski and Swartz were stealing $ 37.5 million from the loan program. Kozlowski had loans worth $ 25 mil-lion wiped out while Swartz did not have to repay $ 12.5 million from the loan pro-gram. A third person, Barbara Jacques, who joined Tyco as a secretary in 1986, also had $ 1 million forgiven from the loan program. The prosecutors in the first trial asked why a secretary also benefited from the select Tyco forgiveness program. The reason was, they concluded, that Jacques had an affair with Kozlowski starting in 1986 when he was still married to his first wife. The prosecution also concluded that Kozlowski must have controlled the forgiveness program to allow only himself, Swartz, and Jacques to be able to participate in the program. Jacques would eventually be-come the event planner for Tyco and was in charge of coordinating the infamous fortieth birthday party in Sardinia, Italy, for Kozlowski?s wife. Linda Auger, head of Tyco?s accounting department, testified in court that Kozlowski used his loan account to buy an $ 8 million painting, $ 50,000 in flowers for a Christmas party, and restaurant tips that sometimes reached up to 50 percent of the bill on Kozlowski?s corporate credit card. In 1998 Kozlowski used his account to pay for his $ 8.3 million investment in the New Jersey Nets and to buy a 1999 Porsche Carrera for his future wife. In September 1999 he used the account to buy his own sailboat, Endeavour, for $ 13.5 million. In 2001 Kozlowski used his account to purchase a $ 5 million diamond ring for his wife.
KEY EMPLOYEE RELOCATION PROGRAM
The employee relocation program was designed to compensate employees when they moved to the New York office of Tyco. After the board approved the design and use of the program in 1995, it was alleged that Kozlowski and Swartz adjusted the scope of the program. The limited scope of the program was based on the legal opinion of a Boston law firm that concluded that if additional benefits were given to the executives as part of the relocation program, it would be considered additional compensation for the executives, which would require a disclosure of that information in Tyco?s proxy statements. The two executives told Barbara Miller, who was Tyco?s treasurer from 1993 to 1998, that the relocation program would now include additional expenses such as paying for second homes for executives and paying for private school tuition for children of the executives. At the time of this adjustment, Swartz had three school aged children. Miller had testified that Swartz would give her handwritten alterations to the criteria of the program.
TYCO BONUS PROGRAM
In 2002 the Tyco Bonus program was introduced even though it was not authorized by the board of directors. The purpose of the program was to forgive relocation loans for employees who had bought homes and moved to the Tyco offices in Boca Raton, Florida. As a result, Tyco paid for the homes of the employees transferred to Florida as well as the related taxes when they purchased the houses. When Patricia Prue, who was head of Tyco?s human resources department from 1998 to 2002, asked Swartz if this bonus plan had been approved by the board of directors, he and Kozlowski told her the program had been approved. Kozlowski received a forgiveness loan of $ 33 million from the program, while Swartz got $ 16.6 million. A total of $ 96 million was paid to approximately fifty employees in September 2000.
PRICEWATERHOUSECOOPERS, TYCOS EXTERNAL AUDITOR
On February 7, 2003, prosecutors accused PricewaterhouseCoopers (PWC) of knowing about the unauthorized bonuses and loans and not investigating them. It was re-ported that PWC met with Kozlowski and Swartz about the unauthorized transactions and PWC had determined that they were not material and did not need to be disclosed. The SEC accused Richard Scalzo, who was a partner at PWC and the chief external auditor for Tyco, of ignoring the accounting practices that were occurring at Tyco. The SEC claimed that Scalzo did not press for information pertaining to the unauthorized loans and bonuses and other extravagant perquisites that were given to the top executives at Tyco. Based on his actions in the Tyco account, Scalzo agreed to an SEC settlement that stated he would no longer be allowed to practice as an accountant before the SEC, meaning that he would not be allowed to be an auditor. An example of Scalzo not performing due diligence was that he knew that Tyco had a general reserve that was being used to offset expenses that management had not anticipated. The setting up of this reserve is not allowed under generally accepted ac-counting principles. In addition, Scalzo knew that Kozlowski and Swartz had borrowed $ 35.5 million and $ 8 million, respectively, interest free. Scalzo agreed with Swartz?s argument that the loans were not material. Tyco?s former senior vice president for finance testified in court that Scalzo knew of the $ 96 million in forgiveness loans that were implemented in Bonus 2000 and did not stop it when it was classified as a direct cost associated with an initial public offering of the Tyco optical fiber subsidiary. Scalzo reportedly stated that was an unusual accounting treatment but he would not overturn the transaction. In court, Scalzo testified that he did review how some of the bonuses and loans were accounted for on Tyco?s books. When asked if he ever verified that the board of directors had approved the bonuses and loans, Scalzo said that he did not because it was not part of the auditing procedure.
THE BEGINNING OF THE END
On September 29, 2003, the first trial of Dennis Kozlowski started in Manhattan. The prosecutor in the courtroom accused Kozlowski and Swartz of shamelessly violating the trust that investors had in the management of Tyco. In addition, the prosecutor accused the two former executives of considering Tyco assets to be their own and that they were using them when the executives wanted Tyco to pay for their expenses.
On November 4, 2003, Tyco announced a net loss of $ 297.1 million for the quarter and stated that it would close 219 operations and lay off seventy- two hundred employees, which represented 3 percent of its workforce. On November 11, 2003, Tyco announced that it had signed a five- year contract with Legal Knowledge Company so every employee could take ethics classes. It was the first comprehensive ethics training program ever at Tyco. On March 18, 2004, the prosecution in the trials of Kozlowski and Swartz concluded its closing arguments and the jury was sent out to reach a verdict. The chance of a mistrial became larger and larger as notes from the jury commented that the atmosphere within the jury room became poisonous with one jury member holding out. The suspected juror was Ruth Jordan, also known as Juror No. 4, who was a former teacher with a law degree. On March 26, 2004, Jordan gave the OK sign to the defense table as she walked past it. On April 2, 2004, Judge Michael Obus declared a mistrial after the judge had been informed that one of the jurors had complained about being pressured into convicting the two former Tyco executives. The other jurors stated that after twelve days of deliberations that the rest of the group was ready to convict both men on many of the most serious criminal charges presented by the prosecution. The Manhattan district attorney?s office immediately stated that it would have a retrial for Kozlowski and Swartz. In October 2004 Kozlowski?s New York apartment, home of the $ 6,000 shower curtain, was sold for $ 21 million. The price included many furnishings but not the shower curtain because prosecutors had taken it for evidence in his trial. On April 27, 2005, Dennis Kozlowski took the stand in defense of the charges against him in his retrial. He did not take the stand in the original trial. He denied that he had committed any crimes and that his goal was for Tyco to grow as a company. Kozlowski could not tell the court why the $ 25 million that was a forgiveness loan from Tyco was not reported as income on his 1999 W- 2 form. He stated in court that he wasn?t thinking that he had a forgiveness loan when he signed the tax form.
On May 31, 2005, the jury deliberations started for the retrial of the two executives. On June 17, 2005, L. Dennis Kozlowski and Mark Swartz were convicted of fraud for falsifying business documents, grand larceny, and conspiracy. After ten days of deliberations, both men were convicted on twenty- two criminal counts and were acquitted on one count of falsifying business records. Ruth Jordan, the OK juror from the first trial, commented that she was a little shocked because she still believed they were both not guilty. The jurors in the second trial stated that they felt that Kozlowski was not believable and that Swartz was a very good liar. An executive who is caught stealing money from his employer is guilty of an extremely egregious crime with the executive being sentenced to the maximum term allowed by law. No, this was not the prosecutions recommendation for the two Tyco executives; the author of this statement was L. Dennis Kozlowski, who wrote a letter to the sentencing authorities after a conviction of an assistant controller at Tyco in 1995. The prosecution weighed whether to include this letter when Kozlowski and Swartz were to be sentenced for their crimes.
After the conviction of Kozlowski and Swartz, the government inventoried both of their assets to determine what could be seized for restitution with the proceeds going back to Tyco and its investors. The government claimed that combined, the two executives looted Tyco of more than $ 600 million, which included illegal stock trans-actions. Some of the assets are listed in Table 3. On September 19, 2005, Dennis Kozlowski and Mark Swartz were both sentenced to the same prison terms. The judge sentenced them both to eight years and four months to twenty- five years for their crimes. Both men would be eligible for parole after six years, eleven months, and nine days. The maximum sentence they could have faced was fifteen to thirty years, and the minimum was one to three years. The court also ordered the two executives to pay $ 134 million in restitution to Tyco, and Kozlowski was fined $ 70 million and Swartz was fined $ 35 million. The prosecutors had asked for the maximum sentence and concluded that Tyco had become a global symbol of kleptocratic management. Because
Kozlowski and Swartz were convicted in state court and not federal court; they would be sentenced to a state prison, considered to be much harder to serve their time than a federal prison, which houses white- collar criminals. In New York State, if a convicted felon is sentenced to more than six years in jail, he or she is usually sent to a maximum- security state prison. The state prison houses mostly violent offenders and the inmates get paid $ 1.05 per day for doing six hours of work.
On the same day, the SEC recommended that an accounting fraud case be started against Tyco for allegedly inflating its profits by approximately $ 1 billion. A defense attorney for the executives complained that the SEC intentionally announced the investigation the same day as the sentencing to influence the length of the sentence for the two men. On April 17, 2006, Tyco settled with the SEC by paying a fine of $ 50 million for artificially inflating by $ 1 billion from 1996 to 2002 profits it reported to the SEC.
In an ironic twist, on May 3, 2006, Tyco sold two of the paintings that were shipped in empty boxes in New Hampshire for $ 7.8 million. Fleurs et Fruits by Renoir sold for $ 2.8 million and Pres Monte- Carlo by Monet sold for $ 5 million. Nine days later Kozlowski agreed to pay $ 21.2 million to settle tax evasion charges that had been filed against him in New York for the purchase of the artwork. Kozlowski also agreed to pay $ 3.2 million in sales taxes that were not paid and an additional $ 15 million for fines and penalties related to the tax evasion.
In June 2006 Kozlowski requested that Tyco reimburse his legal costs under his officer and director liability policy at Tyco. Kozlowski had submitted a claim of al-most $ 17.8 million to Corporate Officers & Directors Assurance Company, which had provided liability insurance for Tyco. In an apparent case of what have you done for me lately, Karen Kozlowski filed for divorce on July 31, 2006. Karen Kozlowski, who enjoyed her $ 2 million fortieth birthday party in Sardinia, had declared that their marriage had been irretrievably broken. She had requested that a lien be put on their Boca Raton mansion to protect the asset from the government and potential lawsuits. The fifteen- thousand- square- foot waterfront estate was purchased for $ 19 million using interest- free Tyco loans. The settlement requested that all of the assets of the couple be equally distributed with the additional stipulation that Dennis pay Karen financial support. A prisoner in the New York state penal system averages a wage rate of one dollar per day.
In an ironic full circle, on December 15, 2006, New York state sales tax charges against Kozlowski were dismissed when prosecutors reached a deal with the former CEO. Kozlowski had agreed to pay approximately $ 21.2 million to pay off his tax liabilities as they related to New York income and sales taxes. Along with the $ 21.2 mil-lion, Kozlowski had also agreed to pay $ 97.7 million in restitution. The dismissed charge came when Kozlowski had already liquidated $ 125 million in assets to pay for the penalties and fines.
Excerpt From Essay:
Essay Instructions: I need to answer the 3 "REQUIRED TO ANSWER" questions about the next case regarding Australian Corporations Law, more specific: Duties of Directors. I'll send scanned the relevant chapters of the prescribed textbook but I need references to some of the other books I'm writing down as well. The Citation Style I need is the Australian Legal Citation one, I am writing down a link which takes you to the Guide for this Citation Style.
Hampton Park Pty Ltd (HP) has four directors: William, Jack, Susan and Gail. William is the managing director of the company while Susan and Jack are non executive directors of the company. Susan is an experienced business woman with other business interests and she is not involved in the running of the company. She leaves the running of the company to William and relies on him. She believes that if there is any problem in the company William will let her know. Jack is also an experienced businessman who sits on a number of other company boards. Jack was asked to sit on HP's board for his financial knowledge and experience but William had assured him that the company’s Chief Financial Officer was one of the best and his role on the Board was to lend financial credibility to the company. Based on William's assurances Jack did not involve himself directly in the running of the company or the oversight of its financial position.
George is (HP's) chief Financial Officer. In July 2009, while the company's financial position is showing signs of deterioration, George advises that the accounts show a profit and HP would have a solid basis for paying a dividend. In July 2010, the company's financial position worsens. Despite being fully aware of the company's deteriorating financial position, George informs William and the Board that the HP has made a technical profit under s 254T of the Corporations Act 2001, and HP could declare a dividend.
Unbeknown to George the basis for declaring the dividend was altered in late June 2010 with the introduction of a different test for the declaration of dividends. George had become aware of the change in the law in September 2010 but he failed to inform the Board of HP before the Board signed off on the 2010 financial reports. In September of 2010 the Board signs off on the company's 2010 financial statements.
As a result of this favourable advice given to the Board by George, the board of directors decides to declare a dividend to members. Susan was absent from the meeting. Shortly after the dividend was paid the company went into liquidation.
REQUIRED TO ANSWER:
a) Advise whether there have been any breaches of the directors and officers duty of care under the Corporations Act and the consequences or penalties of any such breaches.
b) Also advise whether there have been any breach of directors duties in relation to insolvent trading.
c) Finally, advise whether any defences are available to the directors and what penalties may be imposed upon them if they are found to have breached the insolvent trading provisions under the Corporations Act 2001.
(Part a) 12 marks and Parts b) and c) 18 marks. Total of 30 marks)
Lipton, P., and Herzberg, A., Welsh, M, Understanding Company Law, 16 edition Thomson Reuters 2012.
Students should remember to look at the Lipton and Herzberg website. www.lipton-herzberg.com.au
Harris, J. Hargovan, A. Adams, M. Australian Corporate Law LexisNexis Butterworths 4th edition, 2013.
Austin R.P. & Ramsay, I., Ford's Principles of Corporations Law, Butterworths, Australia, 15th edition, 2012.
Baxt, R., and Fletcher, K.L., Fridman, S., Corporations and Associations Cases and Materials on, Butterworths, Australia, 10th edition, 2008.
Parker, Clarke, Veljanovski, Posthouwer, Corporate Law, Palgrave 1st edition 2012
Hanrahan, P., Ramsay I., Stapledon G., Commercial Applications of Company Law. CCH 14th edition 2013
Redmond, P., Companies and Securities Law - Commentary and Materials, Law Book Co., Sydney, 5th, 2009.
Ciro T, Symes C, Corporations Law in Principle LBC Thomson Reuters, Sydney, 9th edition 2013
Li, G, Riley, S. Applied Corporate Law: A Bilingual Approach LexisNexis 1st Edition 2009.
Cassidy, J. Corporations Law Text and Essential Cases. Federation Press, 3rd edition Sydney 2010
Harris, J. Corporations Law, LexisNexis Study Guide 1st edition 2008
Harris, J. Butterworths Questions and Answers Corporations Law:, LexisNexis, 3rd Edition Sydney 2009.
Fisher S, Anderson C, Dickfos, Corporations Law - Butterworths Tutorial Series, 3rd Edition Butterworths, Sydney 2009
Tomasic,R.,Jackson,J.,Woellner,R., Corporations Law - Principles, Policy and Process 4th Edition Butterworths., Sydney, 2002.
Tomasic, R. Bottomley,S. McQueen,R. Corporations Law in Australia, 2nd Edition Federation Press, Sydney 2002.
Latimer, P, Australian Business Law CC, 2013 Edition.
Vermeesch,R B, Lindgren, K E, Business Law of Australia Butterworths, 12th Edition, 2011.
Pentony, Graw, Lennard & Parker, Understanding Business Law 5th ed Butterworths, 2013.
Davenport, S and Parker D, Business and Law in Australia, Thomson Reuters, 2012
Fitzpatrick, Synes, Veljanovski, Parker, Business and Corporations Law; LexisNexis 1st edition 2011
Crosling G M, Murphy H M, How to Study Business Law 4th Edition, Butterworths, 2009.
• See chapter 13.4 and 13.5 in Lipton,Herzberg & Welsh 16th Edition
In law, the preferred referencing style is footnoting. Students are reminded that they will lose marks if they merely reproduce passages copied word for word from texts and other references without attempting to convey information and express ideas in their own words. Of course this does not preclude the intelligent use of relevant quotations in respect of which proper references are given.
It should be noted that the references must be given in respect of all material included in the essay. References are not to be confined to situations in which the writer is citing a particular case or using a direct quotation. For example, if the writer is putting forward a legal proposition or using a statement or idea drawn from a specific source, that source must be acknowledged by reference. It is essential that references be properly acknowledged at all times and marks will be deducted if this is not done. References may be acknowledged by numbering them consecutively throughout the essay and by giving details of the references by way of numbered footnotes at the bottom of the relevant page, or by way of a list at the end of the essay. Note carefully that the edition and page numbers of references must be given: it is not sufficient to merely give the name and author of the work. When referring to cases, the full case citation must be given. In addition, a bibliography should always be included at the end of the essay. Students should contact the lecturer if they are in any doubt as to the requirements for the giving of references.
Referencing: Footnotes or end-notes must be used to acknowledge the source or sources of information contained in the assignment. Footnotes are preferred, but either will be accepted. In regard to the acknowledgment of references and matters of style and presentation, students are referred to:
1. Australian Guide to Legal Citation ??" VU Library Homepage. For all referencing questions for your assignment or any legal writing See: Australian Guide to Legal Citation: The VU Library has a 4 page edited version under Information for researchers: Click on Information for researchers and then click on Referencing and then click on Style Manuals. A copy of the Australian Guide to Legal citation is also available on Webct.
Also see Monash Legal Abbreviations for abbreviations of legal publications.
2. G.R.E. Phillips and L.H. Hunt, Writing Essays and Dissertations,
3. G Campbell, The Little Black Book. (available in the bookshop).
Students are required to pay careful attention to spelling, expression, and legibility in the writing of their essays.
There are faxes for this order.
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