Taking Down the Lion: The Rise and Fall of Tyco's Dennis Kozlowski (13 page)

It seems Walsh left the meeting believing Kozlowski asked him to keep the payment a secret. If so, it may be another example of Kozlowski’s failure to properly communicate and assess risk when dealing with someone he trusted—like when he hired his wife’s friend to decorate the Fifth Avenue apartment and ended up with a $6,000 shower curtain. Former Tyco Director Robert Monks said, “Dennis wouldn’t have said no to Frank Walsh. He respected Walsh, looked up to him—he trusted him.”
26
According to both Walsh and Kozlowski, the payment was fair. And they didn’t feel compelled to memorialize the agreement until Walsh was asked to supply an invoice for his services weeks after the deal closed.

Although the payment was legitimate, the degree of informality was inappropriate. Walsh and Kozlowski should have negotiated a fee up front if both believed Walsh was in a position to provide valuable services to Tyco. There should have been an express written agreement and the payment should have been disclosed to the rest of the Board. But as often happened in Tyco corporate headquarters, an informal agreement between two people who trusted each other was all that existed of the negotiation. When Walsh and Kozlowski needed evidence of what they discussed, there was little available. In their defense, neither Walsh nor Kozlowski imagined they would need documentation. It seemed neither man believed he was doing anything wrong at the time. However, doing business with someone he trusted once again came back to bite Dennis Kozlowski in the ass.

Even though Walsh believed Kozlowski asked him to keep the investment banking fee quiet, many people in the company were aware of and involved in processing the payment. Based on the number of open communications between Walsh and the company, the payment of the investment banking fee was not a closely held secret. Tyco requested and Walsh provided an invoice—not in a clandestine meeting in a dark alley where a top-secret document was passed between gloved hands, but via a company fax machine during a normal business day. Moreover, the receipt for the charitable contribution went to Michael Robinson, not to Kozlowski or Swartz.

Former Tyco Executive Vice President Brad McGee testified that he learned of the Walsh investment banking fee when documents arrived at CIT in 2001. McGee was working in the newly acquired finance unit at the time. In McGee’s presence, then CIT Chief Executive Officer Al Gamper discussed with Mark Swartz the methods to be used to account for the fee. Would it be reflected on CIT’s books or on Tyco’s? At the time of this conversation, Gamper was slated to soon join the Tyco Board of Directors; it would have been unwise to forward documents to him and
discuss accounting methods with him if Kozlowski and Swartz intended to keep the Walsh investment banking fee a secret. Gamper could have easily discussed the payment with other Directors.
27

In addition to all of the other documents and communications, Walsh completed at the end of fiscal 2001 his annual Directors and Officers Questionnaire (DOQ), an instrument used to collect information needed to prepare the proxy and annual report. Walsh included the $10 million investment banking fee on his DOQ.
28
Both the fee and the charitable contribution were disclosed as related-party transactions in Tyco’s fiscal year-end 2001 Proxy Statement, which was filed with the SEC and available for public viewing:

Mr. Walsh, a director, was instrumental in bringing about the acquisition by a subsidiary of the Company of The CIT Group, Inc. (now Tyco Capital Corporation) of Livingston, New Jersey. For his services, Tyco paid Mr. Walsh a fee of $10 million. In addition, at Mr. Walsh’s request, Tyco contributed $10 million to a charitable fund established under The Community Foundation of New Jersey. Mr. Walsh, as trustee of this fund, recommends the public charities to which contributions are made. At the time of the acquisition, Mr. Walsh owned 50,000 shares of common stock of The CIT Group, Inc., which were converted to 34,535 Tyco common shares at the exchange ratio applicable to all stockholders of CIT.
29

Although the payment appeared to be processed in the regular course of business and was disclosed to the SEC as required, it became clear that most of the Directors on Tyco’s Board were unaware until they read the 2001 fiscal year-end Proxy, after it was drafted in January of 2002, that Kozlowski authorized and Walsh received the $10 million payment.

The information was not well received.

During trial testimony, former Director John Fort said he received a phone call from Kozlowski before the regularly scheduled Board meeting in January of 2002 during which Kozlowski told him about the Walsh payment. Fort recalled that “[Kozlowski] told me that one of the matters we needed to take up [at the] upcoming meeting was to approve the payment to Mr. Walsh as a Board because it had to go in the proxy statement which was close to being ready to go to the printer. It was disclosed, something that had to be disclosed to the shareholders and we needed to approve it so that could go in the proxy that way.”
30

Fort then told the jury about the rest of that telephone conversation. He said, “ . . . we talked about it and Dennis told me that at the time the acquisition was under consideration, Frank had told him that if this thing went through, you know, he probably should get a fee. It sounded like it was some sort of a joking fashion, but afterwards Frank asked for a fee. He asked for a 40 million dollar fee and Dennis
had cut it back to 20 million and paid him.” Fort said he spoke to two or three other Directors prior to the Board meeting but that he did not speak directly with Frank Walsh about the investment banking fee.
31

The Huddle

By all accounts, the Tyco Board’s huddle in Boca Raton, Florida on January 16, 2002 did not go well. “Huddles” were informal gatherings of Directors for which no minutes were prepared to memorialize discussions and decisions.

By the end of 2001, a month before the huddle and just six months after the CIT deal closed, the acquisition had already proven to be a serious problem. As a result, Kozlowski spoke to Frank Walsh and asked him to return the fee he received. Kozlowski said, “We were going to have to very quickly spin off CIT, so I asked Frank to return the fee. I thought it seemed like the right thing to do. The acquisition wasn’t working out. But at the time our investment bankers were telling us we could still sell CIT for around $12 billion, which would net somewhere between $2 and $3 billion for Tyco. Frank knew that and said there was no reason he should return the fee he earned. The company was still going to profit from the deal and there was no reason he should return the fee.”
32
Walsh made a good point. Certainly Goldman Sachs and Lehman Brothers weren’t going to return the fees they received as part of the CIT deal. By the time the Directors huddled in Boca Raton on January 16th, Kozlowski felt comfortable defending his decision to authorize the payment to Walsh, but from the reaction he received when he spoke to John Fort before Board members arrived in Florida, he suspected he and Walsh were going to face a few angry Directors.

The Walsh payment wasn’t raised until near the end of the huddle, after the Directors wrapped up preliminary discussions about splitting Tyco into four separate companies. It was an intense day; the weight of the agenda items betrayed the informality implied by dubbing the meeting a huddle. And there were no minutes—
the Directors did not document their discussions on January 16, 2002, even though the issues were clearly of great importance to Tyco shareholders.

Once the issue was broached, some of the Directors became very angry about the payment to Walsh and insisted that he immediately return the $10 million fee.
33
In the days before the huddle, Walsh learned that at least a few of his fellow Directors had questions about the payment, so he sought the advice of independent legal counsel who confirmed in writing that the investment banking fee was appropriate. During the huddle, Walsh presented a letter dated January 15, 2002 from James F. Tannenbaum of Stroock & Stroock & Lavin LLP opining that nothing in Tyco’s bye-laws limited the company’s ability to pay Walsh an investment banking fee and that “even a cursory review of our data base has identified a number of instances in which finder’s fees have been paid to a director in connection with an acquisition.”
34

Despite the opinion of counsel, and even though the Directors should have had full access to and knowledge of the company’s bye-laws, some of them questioned whether payment of the fee required Board approval. Several years later during the criminal trials, the same Directors still had no definitive answer to that question.
35
Notably, some of the Directors were supportive during the huddle and felt Walsh rightfully earned the fee.
36
But a few others levied ugly accusations at Walsh, and according to the findings of fact of Judge Cote in
Tyco. v. Walsh,
“the Board told Walsh to return the payment and advised him that if he refused, he would not be re-nominated to the Board.”
37
At that point, Walsh reportedly picked up his things, told his fellow Board members “
adios,
” and left the meeting. That was the last time Frank Walsh participated in activities of the Tyco Board of Directors.
38

* * *

It was P.E., and the world had changed. In the highly charged post-Enron environment, the Tyco Board was subjected to unprecedented scrutiny and the Directors had serious issues to address in a very hostile environment. In addition to voicing concerns about the payment to Walsh during the January 16th huddle, they discussed and then officially decided a few days later during the January 20, 2002 Board meeting to break up the company. In addition to the stress induced by the Walsh controversy and the big decisions they made about the future of the company, the Directors had to deal with the rapidly declining price of Tyco stock (TYC). Just a few weeks earlier, TYC traded near $85 a share, and the company had a record-high market capitalization of $120 billion in December of 2001.
39
But by the end of January 2002, the stock had dropped below $50.
40
Tyco Directors were no doubt anxious about the state of the company. It was a difficult time for leaders of all large publicly traded corporations, but the leadership of Tyco seemed to suffer more than most.

Even so, it’s difficult to reconcile the Tyco Directors’ reaction to the payment Frank Walsh received. It was not unlike many other related-party transactions—other payments received by Directors over many years. Plus the Walsh payment was exactly like expenditures Dennis Kozlowski had approved hundreds of times.

During the criminal trials, John Fort was asked if Kozlowski had the authority to pay investment bankers in connection with acquisitions to which Fort testified under oath, “Yes, he did.” Fort was asked if Kozlowski had a duty to disclose the Walsh payment to the Board of Directors. Fort testified under oath that “[t]he obligation was on Mr. Walsh, I don’t know of any obligation on Mr. Kozlowski.”

When asked if the Tyco bye-laws allowed a payment like the one Walsh received in connection to the CIT acquisition, Fort explained, “A director can act by himself in a professional capacity with the Board and receive a fee for it.” Fort continued his explanation when he told the jury that he didn’t know if the Board had any authority to approve or disapprove fees paid to Directors for services they sold to Tyco. It seemed such payments simply had to be disclosed.

Fort read in open court from the Tyco bye-laws: “Any director who, whether directly or indirectly, has an interest in a contract or proposed contract or arrangement with the company shall declare the nature of his interest at the meeting of directors during which the question of entering into the contract or arrangement is first taken into consideration.”
41

The same section of the bye-laws provided that “[a] Director shall not vote (nor be counted in the quorum) on any resolution of the Directors in respect of any contract or arrangement in which he is to his knowledge materially interested, and if he shall do so his vote shall not be counted. . . .”
42
For Frank Walsh, Dennis Kozlowski, and Mark Swartz, the penalty levied because Walsh failed to disclose the payment to the Board of Directors was far greater than having their votes disregarded.

Frank Walsh did not disclose to the Board, at least not in as timely a manner as they wanted, his interest in the CIT acquisition, as was required by the Tyco bye-laws. But he did not vote on the acquisition, which is compliant with the bye-laws. The Tyco Board approved the acquisition of The CIT Group at a special meeting held in Pembroke, Bermuda on March 12, 2001.
43
Frank Walsh was not present and he did not vote.

During that meeting, the Tyco Board empowered Kozlowski and Swartz to acquire CIT. The Board voted “that the officers of the Company be, and they hereby are, authorized and empowered to enter into all such agreements, to execute guarantees and to take all such other action necessary or desirable to implement each of the foregoing resolutions [to acquire The CIT Group].”
44
Relying on the express authority granted to him by that empowering resolution, Kozlowski authorized a payment of $10 million (plus an additional $10 million to charity) to Frank Walsh for services rendered in the CIT acquisition. By all accounts, and according to uncontroverted evidence presented during both trials, Dennis Kozlowski had the authority to approve investment banking fees. He had done so hundreds of times without a single problem.
45
Why was
this
time different?

Twelve

“Oh God, What Now?”

In addition to their collective perception of unfairness, anger about the size of the fee, and concern with the manner in which it was paid, the unexpected reactions of some Directors to the Frank Walsh payment had a lot to do with its timing. The dust from Enron’s implosion was everywhere, and it polluted the air in the Tyco boardroom. Plus for the first time in more than a decade, things weren’t going well. For ten years, it seemed everything fell in Tyco’s favor. But the company’s fortune had shifted, and the fates turned cold. As of January of 2002, everything went wrong.

* * *

On January 28, 2002, Global Crossing declared bankruptcy.
1
Like Tyco, Global Crossing was a Bermuda-based corporation. (In 1997, Tyco became a corporate citizen of Bermuda during a reverse merger with ADT Limited, an electronic security business then based in Bermuda. The ADT merger was one of the largest and most successful mergers and acquisitions during Kozlowski’s tenure as CEO.) Global Crossing also operated in several of the same industries as Tyco. The two companies were intertwined; Global Crossing bought cable from Tyco, sold the circuits on the cable, after which Tyco installed the cable. Kozlowski explained, “When Global Crossing went bankrupt, Tyco investors got spooked. They were investors in Global Crossing as well as Tyco.”
2

When Global Crossing failed, the price of Tyco stock fell. The bankruptcy undoubtedly made Tyco shareholders anxious and played a part in the declining stock price. But the company was simultaneously and negatively affected by so many things during the first half of 2002, it’s impossible to pinpoint the extent to which any single factor caused Tyco’s stock price to suffer.

The first several months of 2002 became extraordinarily difficult for Tyco and Kozlowski. After the Walsh investment banking fee was disclosed, after the announcement of Global Crossing’s bankruptcy, while dealing with the post-9/11
economy amid allegations of Enron-like accounting irregularities and other rumors floated by short-sellers and journalists, and with the company’s announced plans to split into four separate publicly traded corporations, the value of Tyco stock continued to tumble. In his testimony during the trials, Brad McGee, who was the head of investor relations and Tyco’s spokesperson for several years, summarized the number and nature of rumors present in the immediate post-Enron environment. McGee said, “There were rumors concerning whether or not there was an SEC investigation of the company, rumors concerning whether there was any type of off balance sheet financing vehicles. There were rumors concerning how we accounted for dealer accounts. There were a whole host of rumors, mostly issues that [had] been affecting other companies where people were trying to apply them to us.”

McGee explained that “we drew down on backup bank lines and there were rumors in the market of whether Tyco was going to declare bankruptcy. Rumors in the market that our auditors quit. Rumors in the market Dennis quit. Rumors in the market Dennis fired [CFO] Mark [Swartz], and rumors Mark had quit. There was a lot of anxiety concerning the stock and every hour there was a different rumor we had to face.” Asked if any of the rumors were true, McGee said definitively, “No they were not.” McGee emphasized that he had a duty to Tyco shareholders to address false information and rumors that surfaced because the faulty information could have a devastating effect on shareholders. He explained that Tyco managers were responsible for providing complete and accurate information. “As part of that,” McGee said, “we have to make sure information in the market about the company that is not accurate is corrected.” McGee also made it clear to the jury that market perception was the key driver of stock price.
3

Mark Maremont was a reporter for the
Wall Street Journal
who wrote prolifically about Tyco for a number of years out of the newspaper’s Boston bureau. Kozlowski believed Maremont had a grudge against Tyco because so many of Maremont’s articles appeared to him to be unduly negative, and Kozlowski saw in the articles what he knew to be sensationalized versions of the facts.
4

McGee explained that “Mark Maremont always wrote with an investigative bent. Before he was with the
Wall Street Journal,
Maremont was an investigator. His mind-set was to look for a scandal.” McGee recalled that “there were times when Maremont had no choice but to write very positive news about Tyco and he did it, but it seemed he reported good news about us begrudgingly.” McGee had to deal regularly with Maremont and his articles and said after a number of years, “when anyone told me that Mark Maremont was on the phone for me, I’d think ‘Oh God, what now?’”

“I can still read an article from the
Wall Street Journal,
” he said, “and know it was written by Maremont without looking at the byline.”
5

Maremont authored an article that appeared in the
Wall Street Journal
in early February of 2002 reporting that Tyco failed to fully disclose 700 acquisitions.
Kozlowski was shocked at the blatantly inaccurate information reported by what was once a reputable source of business news. Even David Tice, the short-seller who questioned Tyco’s acquisition accounting methods for several years, said the information in Maremont’s article was wrong. Tice, whose Prudent Bear fund was described as “a well-known short-seller of Tyco stock,” was quoted in a
CNNMoney
article as saying “Tyco is really correct here. They did make the required disclosure in their cash flow statement as far as how much money they spend net of the cash they received of those companies, so I can see Tyco’s point.”
6

Dennis Kozlowski said, “Mark Maremont seemed to want to make a career out of destroying Tyco. The kinds of expenditures he sensationalized in his article were very small—like when Tyco bought out ADT independent reps with 50 accounts. Those are the types of acquisitions that Maremont complained about. Yes, we disclosed them in our financial statements. No, we didn’t issue a press release when we bought out a guy in Texas with a handful of home security accounts. If Tyco issued a press release every time the company spent small sums of money, Tyco press releases would have become meaningless and when the company needed to announce something material, something significant, it would’ve been overlooked due to the sheer volume.”
7

Even as he cast aspersions about Tyco on the pages of the
Wall Street Journal,
Maremont quoted in his article an accounting professor from Pennsylvania State University’s Smeal College of Business who said that “Tyco’s acquisition disclosures seem to be adequate under accounting rules, because investors were properly given the net cash spent on all its deals.”
8

The day Maremont’s article was published—February 4, 2002—Tyco’s CFO Mark Swartz and head of investor relations Michele E. Kearns wrote a “shame-on-you” letter to the editor of the
Wall Street Journal:

To The Editor:

Today’s story by Mark Maremont, “Tyco Made $8 Billion of Acquisitions Over 3 Years But Didn’t Disclose Them,” is blatantly false and malicious. The 240,000 employees of Tyco, to say nothing of your readers and the entire investment community, expect and deserve far better from
The Wall Street Journal.

With regard to acquisitions made but not announced in 2001, the spending you call “undisclosed” was indeed disclosed by Tyco in its 2001 cash flow statement (page 46 of Tyco’s 2001 Annual Report), in note 2 (page 54 of Tyco’s 2001 Annual Report) and the MD&A section (page 31 of Tyco’s Annual Report). Similar disclosures for 2001 and all prior years are contained in each appropriate Tyco Annual Report on Form 10-K and Quarterly Report on Form 10-Q.

With regard to the quality of Tyco’s disclosures, we concur with Professor Ketz, who according to your story said, “Tyco’s acquisition disclosures seem to be adequate under accounting rules, because investors were properly given the net
cash spent on all its deals.” But this isn’t just about complying with the rules. In our extensive discussions with Mr. Maremont, we asked him to give us examples of other companies similar to Tyco that do a better job than Tyco on these types of disclosures. He was unable to provide a single example. Furthermore, at the end of our several hours of conversation with Mr. Maremont, he stated: “I understand exactly what the situation is. It’s all right there in the cash flow.” Bottom line: beyond the inflammatory headline, and given that the story itself concedes that everything that must be disclosed is disclosed, we fail to see the news value of the story you gave such prominence to in today’s paper.

Perhaps it’s a sign of the extraordinary times we’re in that it seems necessary to remind
The Wall Street Journal
that there is a stark difference between issuing a press release and making disclosures. Tyco made over 350 acquisitions in 2001. Of these, over 90% were for less than $50 million. For a company with 2001 revenues of $36 billion, it makes no sense to issue press releases on transactions of this size. Many also involve private sales where, as is customary and common, we are bound from making public announcements by confidentiality agreements signed with the selling individuals or families. All of this was told to your reporter. Surely
The Wall Street Journal
is not suggesting that Tyco issue a press release each time it buys a small, privately held fire protection contractor or alarm company. And if indeed you are suggesting that, are you suggesting it to other companies as well, or just to Tyco?

In the current extraordinary market environment, more than ever,
The Wall Street Journal
has a responsibility to inform rather than sensationalize. In our view, and judging by the reactions to your story we have received this morning from many of our investors and analysts, today’s article failed that test.
9

In addition to having an immediate negative effect on the value of Tyco stock, the prolific amount of false information circulated in 2002 caused long-term problems. For example, the spin and inaccurate reporting found in sensationalized stories and the misstatement of facts included in dozens of articles eventually found their way into a multitude of lawsuits filed against Tyco, its Directors, its independent auditor, and against Kozlowski, Swartz, Belnick, and Walsh. The allegations included in complaints filed in many state and federal courts were lifted from articles like the one Mark Maremont wrote in February of 2002—sometimes the information appeared word for word in court documents.

For instance, these “facts” from Maremont’s article appeared in the complaint for a class action securities action that ultimately settled for $3.2 billion:

2. The Tyco Defendants’ Failure to Disclose Numerous Acquisitions During the Class Period

148. In addition to engaging in manipulative accounting, Tyco failed to disclose the sheer number of companies it was acquiring, and the amount it was
paying for each. According to a February 4, 2002 report in THE WALL STREET JOURNAL (“Tyco Made $8 Billion of Acquisitions Over 3 Years but Didn’t Disclose Them”), defendant Swartz admitted that Tyco had spent about $8 billion over the three previous fiscal years on more than 700 acquisitions that were never announced to the public. . . .
10

With the permanency of everything that appears on the Internet and the general assumption that if something was published, it must be true, what originated as clearly inaccurate, false, untrue, unfair, sensationalized, and sometimes malicious lies were over time transformed into “the truth.” For example, if erroneous information that appeared in an outlet like the
Wall Street Journal
was copied by an attorney into a complaint filed with a court—the inaccurate information represented as a statement of fact (it was in the
Wall Street Journal,
so it must be true, right?)—others relied on the facts stated in a court document, the information then appeared in a dozen new articles, which led to its inclusion in textbooks used in the finest business schools in the United States, and what was in reality clearly inaccurate information over time transformed into the accepted truth. And that kind of “truth” lives forever in cyberspace.

Matt Lauer of NBC’s
Today Show,
when interviewed for an October 2013
Esquire
magazine article, shared his frustration with the same phenomenon—fiction transformed into accepted facts. Lauer was the target of rumors floated by the media when his co-anchor Ann Curry was fired from the morning show in 2012. Lauer said, “The way the media treated what happened with Ann Curry was a disappointing learning experience. I was disappointed by the laziness of the media, the willingness to read a rumor, repeat that rumor, and treat it as a fact.
11

* * *

More difficulties befell Tyco in early 2002 when the company’s formerly stellar credit rating was downgraded. Temporally related to Maremont’s
Wall Street Journal
article, the rapid drop in the price of Tyco stock, and the company’s use of its backup credit lines, Standard & Poor’s lowered Tyco’s rating and put the company on “credit watch” in February of 2002. Fitch and Moody’s followed suit.
12
Kozlowski’s Tyco found itself in unfamiliar territory. Just a year earlier,
Businessweek
ranked Tyco the number one performing company in the S&P 500.
13
But its newly downgraded rating made it impossible for Tyco to retain that coveted spot. In addition, the downgrade prevented CIT (by then renamed Tyco Finance) from upgrading its ratings, which increased the finance unit’s cost of money.
14
Without access to cheap capital, CIT was not performing as it should. For its own sake and Tyco’s, the finance company had to be sold soon after it was integrated into the Tyco conglomerate. Times were tougher than at any other point during Kozlowski’s tenure as CEO. But the worst was yet to come.