Taking Down the Lion: The Rise and Fall of Tyco's Dennis Kozlowski (26 page)

Prue testified that when she, Kozlowski, and Swartz talked about the September 2000 bonuses, they discussed Phil Hampton’s role of in the process. Prue said, “In the meeting I had with Mark [Swartz], Mark told me Dennis had a conversation with Phil Hampton about the loan forgiveness, and that Phil had approved it. In the meeting with Dennis and Mark, Dennis mentioned that Phil, Mr. Hampton in his conversation, at least it was my understanding the Board knew about [the bonuses].” Prue explained her understanding “[i]n the context of Dennis talking about the Board wanting to reward the employees and the contributions that everyone made.” With the blessing of Mark Swartz, Prue requested and received the opinion of outside legal counsel regarding SEC disclosure requirements for the
bonuses paid to Kozlowski and Swartz. Marian Tse of Goodwin, Procter & Hoar in Boston provided the legal advice at Prue’s request.
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Everything about the TyCom bonuses seemed to have been done as per usual at Tyco. The amounts of the bonuses paid to Kozlowski and Swartz were calculated according to the terms of the Incentive Compensation Plan—except both men took only half of the amounts due them, allotting their other collective half to forty other Tyco employees. There were numerous discussions and a clear paper trail that was very easy to follow.

Mark Foley, SVP of Finance at the time of the TyCom IPO, testified at length about discussions he had with several people in Tyco corporate offices and with PwC auditors regarding accounting methods used for the bonuses, which affected the books and records of both Tyco and TyCom. He said he discussed the bonuses with Swartz before they were paid and also said under oath that all of the bonuses in question were discussed with Richard Scalzo, the PwC partner who oversaw Tyco audits. His testimony about the TyCom bonuses filled more than forty pages of the transcript of the second trial.
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If Kozlowski and Swartz tried to conceal the bonuses, as the prosecution alleged, they failed miserably.

No Meetings, No Memos, . . . and No Minutes

Unfortunately for Kozlowski and Swartz, nothing in Compensation Committee minutes reflected the Committee’s approval of the TyCom bonuses. The terms of the Incentive Compensation Plan required Committee approval of pay-for-performance bonuses
before
they were released to the CEO and CFO. According to Kozlowski, Hampton gave him approval and said he would take care of the rest. According to Prue, September of 2000 was Phil Hampton’s first month of service as the Chair of the Compensation Committee. Sadly, Hampton died in April of 2001, before questions about the bonuses were raised.

It turned out that, over the years, the Tyco Board of Directors and the Board’s three committees (Compensation, Audit, and Nominating and Governance) failed to record and maintain meeting minutes as meticulously as anyone needed them to be when Kozlowski and Swartz were indicted. Kozlowski had a well-known distaste for bureaucracy, and a strong “no meetings, no memos” management preference. He believed a minimal corporate staff was the best way to run the company, but the sparse corporate operations that he insisted on when he was CEO did not serve him well when he needed well-kept books and records, and documentation that corporate formalities had been observed, to save him when there were questions. In addition to the Compensation Committee minutes having been written in advance of meetings by someone who didn’t attend the meetings, there were Board huddles and Committee information sessions for which no minutes were created.

Trial testimony revealed other gaps—missing and incomplete minutes that should have but didn’t reflect important decisions of the Board and of its Committees. For example, no Board or Committee meeting minutes reflected the Board’s decision to hire David Boies to conduct the internal investigations in 2002. Furthermore, Boies testified that he attended Tyco Board meetings during the summer of 2002, yet there were no meeting minutes between June 3, 2002 and August 14, 2002—the time frame during which Boies testified that he attended meetings.
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Just as there were no meeting minutes that reflected approval of some of the bonuses paid to Kozlowski and Swartz, and just as no information was found in minutes about the investment banking fee paid to Frank Walsh, there were no minutes reflecting the Board’s approval of fees paid to Director Josh Berman’s law firm. There was no record of Board discussion, disclosure, or approval of fees paid to Berman’s firm.
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Unlike Kozlowski, Swartz, and Walsh, the Manhattan DA did not indict Berman and he was not called as a witness during either of Kozlowski’s criminal trials, even though, according to Kozlowski, Berman was without a doubt the most influential Tyco Director when Kozlowski was the CEO.
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Berman was, however, called as a prosecution witness during Mark Belnick’s trial, which resulted in Belnick’s acquittal. For unknown reasons, the transcript from that trial is sealed. Shockingly, the Tyco Board of Directors’ Audit Committee kept no minutes at all until 2002. Mark Foley, who attended the Audit Committee meetings as the SVP of Finance but was not a Director or a member of the Committee, said under oath that Audit Committee members John Fort, Wendy Lane, and Richard Bodman (the same Director who said under oath during the first trial that he didn’t read the half-billion dollar Retention Agreement when the Board entered into the contract with Kozlowski) didn’t record or retain minutes during the years when the four bonuses in question were paid. Foley testified that he suggested a change, via an email to Director John Fort, in March of 2002:

Q. This is an e-mail from you?

A. Yes.

Q. To John Fort?

A. Yes.

Q. He was at that time the Chairman of the Audit Committee?

A. I believe so, yes.

Q. It says John, in light of everything going on recently, I thought it made sense for us to start keeping minutes of our Audit Committee meetings. That is dated March 6, 2002?

A. Yes.

Q. So up until that time, the members of the committee kept no minutes?

A. Yeah.
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In May of 2001, the Board of Directors approved the sale of $2 billion of Tyco stock to Lehman Brothers. There was a press release to this effect but absolutely no reflection of the Board’s approval in meeting minutes.
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A two billion dollar sale of stock, and not a single mention in the Board’s meeting minutes. It seems no decision was too big to be excluded.

There was no approval of the bonuses paid to Kozlowski and Swartz in the minutes of the Board or of its Committees. Looking at the overwhelming evidence of sloppy, haphazard, negligent record keeping and even the complete failure to record minutes by the Board and its Committees, how could the Manhattan DA, the court, or the jury place any weight on the fact that approval wasn’t found in the minutes? Lots of things were missing from meeting minutes—and sometimes there were no minutes at all. They were clearly not a source of reliable information.

* * *

After the CIT acquisition went bad in December of 2001, after some of the Directors were angered in January of 2002 when they learned of the $20 million investment banking fee paid to Frank Walsh, after the price of Tyco dropped in the post-Enron, post-Global Crossing bankruptcy market, after Kozlowski and the Board announced they were breaking up the company and then backpedaled, causing yet another drop in the stock price, with rumors swirling about accounting irregularities and a spotlight suddenly cast on Kozlowski’s personal spending habits, after the Directors were sued, after Kozlowski was indicted on sales tax evasion charges, and after the Board hired David Boies to conduct an internal investigation and to represent the company in dozens of shareholder lawsuits, the Directors either could not recall approving the TyCom bonuses, or they testified that they did not approve the TyCom bonuses or the other three bonuses paid on nonrecurring gains between 1999 and 2001. Without documentation of the Board’s approval, and without Directors who could remember approving the bonuses, with Phil Hampton dead and unable to confirm the conversations he had with Kozlowski, the Manhattan DA determined that Kozlowski and Swartz stole the money, charged them, and asked a jury to convict them of grand larceny.

* * *

The prosecution asked Patty Prue if she had opportunity to speak with Phil Hampton after Kozlowski and Swartz discussed the TyCom bonuses with her, after they told her Hampton was in the loop and was taking care of Board approval. Prue said yes, she spoke with Hampton at the Compensation Committee discussion sessions and at the Committee’s official meetings in September and October of 2000.
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The ADA asked Prue: “And on any of those occasions did Mr. Hampton indicate to you that he was aware of 32 million dollars in loan forgiveness and gross-ups
being obtained by Mr. Kozlowski?” Prue testified, “I didn’t have any conversations with Mr. Hampton about this benefit.”

Prue was then asked, “And did he ever mention to you that he was aware that Mr. Swartz had obtained 16 million dollars in loan forgiveness and gross-ups in September of 2000?” Prue responded, “No.”

Justice Obus then clarified: “So that I’m clear, you’re telling us that he never raised the subject and you never discussed the subject of the loan forgiveness to either Mr. Kozlowski or Mr. Swartz.” Prue responded, “To Mr. Hampton, that’s correct.”
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It seems the question that both the judge and the ADA should have asked of Prue was if
she
raised the issue of the bonuses with Hampton. She was the head of HR and the management liaison to the Board. She was the source of compensation information the Compensation Committee received. She was very generously compensated by Tyco to perform her duties—in 2000, the year of the TyCom bonuses, Prue was paid more than $5.5 million.

According to Prue, it was her responsibility to keep the Compensation Committee informed about executive pay. In addition to Kozlowski’s face-to-face discussions with her, on September 11, 2000 he sent her a memo about the TyCom bonuses with the subject line “Compensation.” Why didn’t Prue provide that information to the Compensation Committee and request approval? She was the head of HR. More than anyone else in the company, she should have had the most comprehensive understanding of the terms of the Incentive Pay Plan and the procedures it required—she was paid to know and to administer it. She testified that she was never asked or told to hide or conceal any information. She testified that it was her job to inform the Committee. During cross-examination, Kozlowski’s attorney asked Prue:

Q. In terms of performing your professional function as the liaison . . . of the Compensation Committee, did you feel free within the exercise of your own judgment to provide whatever you thought was appropriate to the Chairs of the Compensation Committee . . . ?

A. Yes.

Q. And in creating those packets did you use your best judgment in putting together whatever you thought would be helpful and appropriate?

A. Yes.

Q. Did you personally, for any reason, ever try to hold any information back without being told by anybody, from the Compensation Committee?

A. Never. Never.
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But Compensation Committee members testified that they either didn’t recall receiving information about the TyCom bonuses or that they definitely did not
receive the information. The testimony of the former Tyco Directors was the same regarding all four unapproved nonrecurring gain bonuses—even though Kozlowski and Swartz provided Patty Prue with the requisite information. Why were Swartz and Kozlowski held responsible for Prue’s failure to perform her duties? If what happened at Tyco with the bonuses was criminal, why were Kozlowski and Swartz indicted instead of Prue? Why was she granted immunity? It raises the same concerns and questions as when Kozlowski was indicted for sales tax evasion instead of the art dealer who was legally responsible for collecting and remitting the sales tax—the art dealer to whom the Manhattan DA granted immunity.

During her trial testimony, Prue admitted that she received a severance package from Tyco. In March of 2003, six months after Kozlowski, Swartz, and Belnick were indicted, she signed an agreement with Tyco in which she received a generous separation package in exchange for her cooperation with pending and threatened litigation, her agreement to provide information during investigations, and to testify at trial. Under the agreement, Prue’s legal fees were paid by Tyco, and the company vested shares that even with the deflated price of Tyco stock at the time amounted to more than $2.2 million. She retained real estate in Florida that the company had purchased and she received stock options; the company reimbursed her for state and local taxes she paid for four years; and the company agreed to indemnify her against any losses she might experience as a result of legal actions related to her employment with Tyco. In exchange, Prue agreed not to make any disparaging, critical, or detrimental comments about Tyco or her employment at Tyco, or to talk about the company’s business affairs or financial condition, and Tyco agreed not to give any negative employment references about her.
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Considering her central and critical role in the actions that were considered grand larceny by the Manhattan DA, the SVP of HR walked away with a much sweeter deal,
sans
criminal prosecution and a civil action with Tyco, than did Kozlowski, Swartz, and Chief Corporate Counsel Mark Belnick.

Management Representation Letters

The crux of the charges against Kozlowski and Swartz was that they intentionally and knowingly concealed the bonuses they received; when the company incurred four large one-time gains, the co-conspirators arranged for bonuses to be paid to themselves (and to dozens of others, but the bonuses paid to other employees were not part of the criminal charges because Kozlowski had the authority to set compensation for everyone other than Swartz and himself). It’s difficult to determine what the former executives should have done differently. Other highly paid professionals in the company calculated the amounts due under the incentive pay plan, and Kozlowski and Swartz discussed the bonuses, both in writing and verbally,
with Patricia Prue, the head of HR and liaison to the Board. Mark Foley, SVP of Finance, handled the discussions about how Tyco would account for the bonuses. In addition, Kozlowski and Swartz disclosed the bonuses in a “Management Representation Letter” provided to Tyco’s independent auditor, PwC. In a letter dated December 19, 2000, the executives disclosed that “In connection with the calculation of the $1.760 [billion] gain on the public offering of shares in TyCom Ltd., the Company has deducted incremental bonus expenses of $85.1 million from the net proceeds received. These expenses represent remuneration of key Tyco and TyCom employees, paid solely in connection with their contributions on behalf of Tyco to the operation of TyCom Ltd. in prior periods and to the offering process. The remuneration is incremental to the employee’s customary bonuses and is a direct result of the public offering of TyCom Ltd. shares.”
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In addition to the signatures of Kozlowski and Swartz, the letter was signed by Mark D. Foley and Jeffrey D. Mattfolk, both SVPs. The management representation letter was also provided to the Board’s Audit Committee.