INDIAN INSTITUTE OF MANAGEMENT RAIPUR

PGP BATCH 2021-23

TERM III_Business Ethics and Corporate Social Responsibility

                            Tyco’s Corporate Scandal 2002

  
Submitted To:
Prof. Santanu Bhadra
Submitted By: Group_05

ROLL NUMBER NAME

21PGP224 Shiwangi Priya

21PGP225 Shraddha Kesarwani

21PGP245 Sumit Saha

21PGP249 Suyashi Bansal

21PGP265 Ayush Kumar

21FPM006 Shashwat Ranjan

Introduction: Tyco Corporate Scandal 2002
The Tyco International corporate scandal took place in the year 2002. This case was basically focused on
the unethical business practices which usually happens in the business environment. This scandal also
explains how a company can get disrupted by such unethical practices. Tyco International started as an
investment and holding company but later it grew very fast and acquired many businesses.

This scandal also presents the unethical practices done by the top senior executives, including its CEO
Dennis Kozlowski. Dennis Kozlowski was involved in several unethical practices, and he did some
suspicious financial transactions which were not there in the company’s financial statements. For his
suspicious activities he used to take help of his co executives and also some low-level employees to cover
up the whole illegal financial transactions.

Later court proceedings proved Dennis Kozlowski and CFO Mark Swartz convicted and both got
imprisoned in the year of 2005. After this scandal, the company’s reputation was largely impacted, and
investors of the company lost confidence in the firm. In the year 2017, Dennis Kozlowski was released on
parole in New York city of USA.

Company Background
Tyco International started with two segments of business: security systems and fire protection. Arthur J.
Rosenburg is the founder of Tyco and founded it in 1960. The headquarters of Tyco International is
situated in New Jersey, USA.

It is a global leader in the design, production, installation, monitoring, and support of fire detection and
suppression systems, as well as electronic security services. Tyco Electronics generates around 28 percent
of revenues and is considered as one of the world leaders in supplying good quality electronics products
to the market.

In 1970, Tyco experienced a boom period. In 1980, Tyco was a large firm with more diversified business.

Tyco expanded into three business segments in 1980, namely the Fire Protection section, Electronics
goods segment, and Packaging segment, by ongoing acquisitions, and afterwards went with various
implementations of strategies to gain greater market share for its new business divisions. Tyco
International renamed as Johnson Controls International plc.

Fall of company under Kozlowski

The company's continual and reckless acquisitions aroused suspicions about its operations, raising
suspicion for the Securities Exchange Board to launch an investigation into the company's operations in
1999, but it was a failed attempt as nothing was discovered. The next year, 2001, became the company's
most acquisitive year, with big purchases paving the way for the company's expansion in numerous
industries. The company had a profitable year, with revenues of $3.97 billion dollars on the books. The
rising scepticism of various regulatory organisations throughout a succession of corporate crises was one
of the key factors for the company's demise in 2002.

Corporate Scandal 2002

The Securities and Exchange Commission launched an investigation against Tyco’s C-Level Executives
in the year 2002. As a result of the investigation, some findings came into light in the month of January.
The CEO Dennis Kozlowski, CFO Mark Swartz, and Chief Legal Officer Mark Belnick without any
formal approval, communication, and notifying shareholders had taken more than $170 million loans
from the company. Furthermore, Kozlowski and Swartz had sold shares of the company amounting $7.5
million for $430 million. The SEC filed a formal accusation against them on September 12, 2002.

Following series of events took place at the time of investigation:

● January,2002: The stock value of the company dropped by 19%. Tyco’s financial records were
brought under scrutiny.
● January 29, 2002: Kozlowski stated that the amount of $20 million paid to Frank Walsh was the
founder’s fee for the acquisition of CIT.
● January 30,2002: Kozlowski and Swartz claimed to assure the price of Tyco’s shares, they
bought 500,000 shares each in the open market.
● April 25, 2002: CEO stated reasons for the loss of 96 cents per share in the quarter ending March
31, 2002, and its exceptional impact on the earnings of the company.
● June 3, 2002: Stating personal reasons, Kozlowski resigns from the CEO position. Following,
John Fort assumed the position as an interim CEO.
● June 4,2002: CEO, Dennis Kozlowski was charged with the tax evasion attempt.
● June 10, 2002: The company fired Mark Belnick, Chief Legal Officer.
● June 17, 2002: Lawsuit was pursued against Belnick for breach of fiduciary responsibility and
fraud.
● August 1,2002: Tyco’s CFO Swartz resigns from the company.
● September 12, 2002: SEC filed charges against Kozlowski, Swartz, and Belnick for the
misconduct of multi-million-dollar loans they took out from the company.

Kozlowski and Swartz were charged with:

● Corruption\Conspiracy
● Theft of a large sum of money
● falsifying documents

Tyco suffered a $600 million loss because of their actions.

Belnick is accused of:

 ● Falsifying financial statements
● Failure to disclose loans to investors and Tyco's remuneration committee.

Ethical Misconduct
Unethical Leadership
A Dennis Kozlowski (CEO) was the main person involved in the immoral practices of an
organization. He used his position to his advantage; he manipulated the C-level executive and his
subordinates to misuse their position and engage in unethical practices causing financial misconduct
and frauds. Being, top executive instead of using his position for bringing laurels to the company. He
misuses it to his personal advantage and set a wrong example even by involving his subordinates in
this misconduct.

Unethical Business Practice of Subordinates

Kozlowski was not the sole player in this whole malpractice. The involvement of CFO Swartz,
subordinates and other board members also played a crucial role. The board members-maintained
silence in the whole situation, for example, acquisition of a mansion by Kozlowski and his wife. They
were rewarded directly or indirectly. Kozlowski made sure to keep lower-level employees’ mouths
shut by offering monetary rewards.

Unethical Auditing Practice

PricewaterCoopers (Pwc), was in charge of auditing financial statements of Tyco International. Pwc
failed to report the unlawful financial transactions carried on by the company. As a consequence,
Kozlowski’s unscrupulous activities continued for a long duration.

Principal - Agent Problem

Whenever the principal and the agent take competing interests, a principal-agent dilemma emerges, which
recurrently arises when the agent works only in their interests. In this the principal is the individual who
officially employs the agent to make choices and conduct acts as their representative.

In principle-agent relations, the separation of "ownership" (principal) and "control" (manager) raises the
possibility of a conflict of interest between the two stakeholders. The root drivers of the principal-agent
issue are multiple conflicts of interest and asymmetric knowledge.

This case also highlights the Principal-Agent dilemma. The board believed that the management was
working in the organization's best interests, but the CEO and CFO were acting in their own best interests
and were able to influence the board to suit their needs as a result the company incurred financial losses
and lost credibility amongst the customers as the news of the scam went public.

Making sound ethical decisions demands a well-trained consciousness to moral dilemmas, which is why
frameworks are so crucial. While using the technique on a consistent basis, it becomes so innate that we
need not refer to the accurate stages.

Ethical Frameworks (in continuation with the basic ethic framework

of understanding facts, identifying relevant standards, and
maintaining objectivity)

Blanchard-Peale Framework
Once confronted with a moral predicament, this recommends that you pose a trio of questions. Your
conclusion may be undesirable if you replied no to any of the three questions.

 ‘Is it lawful?’. Will my actions be illegal based on public laws? If not illegal, would I be
breaching core company guidelines?

In this case it was observed that Dennis (CEO) and Mark (CFO) were charged for selling the
company's stock without alerting the shareholders. Kozlowski spent $2 million from the
corporation on his wife's birthday in Italy. 40 Tyco executives used the company's loan
forgiveness scheme to pay off their debts. All these actions are deemed illegal in the eyes of the
court and human behavior.

 ‘Is it fair and balanced?’ Would the choice be seen by others as proper and truthful? Are one
or more stakeholder’s being treated wrongfully without deliberation?

While we may not always be able to make judgments that benefit everyone, leaders should strive
to minimize inequities in their relationships. In this case, Kozlowski was unjust and did not
consider the interests of any of the stakeholders.

 ‘What would it lead me to believe about myself?' Will I be satisfied or displeased about my
decision?’

Tyco lost $600 million because of the inquiry, which found Kozlowski and Mark guilty of
corruption, conspiracy, grand theft, and falsifying records. Furthermore, they were both
embarrassed by their behavior.
 During their time at the organization, both Kozlowski and Mark engaged in unethical behavior.
and were so blinded by their own self-interests that they were oblivious to themselves, failing to
focus on any of the three factors outlined, leading them to engage in unethical behavior.

Markkula Framework
To follow ethical practices, the Markkula framework discusses identifying relevant standards. There are
eight major principles that govern a company's dealings with its stakeholders under this framework.
While most of the principles were applicable in our case, we identified three major principles that were
critical in identifying ethical issues.

 The fiduciary principle refers to acting in the company's and investors' best interests. Dennis and
Mark both failed to provide accurate financial information about the company.
 Respect for other people's property is referred to as the property principle. Tyco's funds were
allegedly used for personal gain without regard for other shareholders.
 Conduct business in a truthful and open manner, as defined by the transparency principle.
Accounting users were denied the right to see the true financial figures in the company's financial
statements in this case.

This framework now includes the concept of objectivity, which ensures that ethical decisions are not
swayed by personal judgement or cultural differences.

To do so, we must ensure that the following parameters are not used to evaluate the decision: We did not
evaluate the actions of the CEO and CFO in this case based on:

 Visibility: This parameter asks us what would happen if the problem was made public?
 Generality: This parameter asks, "What if others in this situation did the same?"
 Legacy: This parameter asks us if this is how we want to be remembered for our leadership.

Outcome/Consequences
 The main challenge faced by the company was the loss incurred of $9.41 billion. It affected the
reputation of the company which led to the fall in the stock value.
 In December 2003, the company had to cease trading on the London stock exchange because of a
fall in the share price.
 The firm’s credit rating dropped by a huge margin.
 Tyco was instructed to pay $50 million into a fund for the compensation of affected investors.
 The company faced challenges in reviving its image as there were 2000 pending cases against the
shareholders of the company.
 The company faced several inquiries pertaining to the accounting records for several years.
Actions taken by the company
 The CEO and CFO were sued, and nine executives were fired as a result.
 For reviving the company, a new structured programme was implemented. This led to an exit of
7200 employees from the company and shutdown of 219 facilities.
 The new management team also attempted to recoup some of their funds. To avoid similar
instance in future, the new board of directors made future agreements and appointed an
independent board chairman rather than TYCO's CEO.
 Erric Pillmore, a new vice president, was also hired. He was instrumental in determining the root
cause of fraud and later became the company's SVP of corporate governance.

Recommendations
From the facts it is clear there were three lines of failure in case of Tyco:

 Failure from the perspective of governance: This includes the failure of the Board to not be able
to judge the various activities undertaken by the CEO and CFO rationally.
 Overpowering greed over ethical leadership: CEO Dennis and CFO Swartz did not act ethically.
They used their power to use the money of shareholders to their advantage.
 Misinformation towards the respective stakeholders: CEO and CFO also justified their expenses
by stating business needs, pressure and making self-judgements about their personal accolades.

Therefore, in line with these failures, following are some of the recommendations that we suggest
for a better future of organizations:

Corporate Governance Audit

In the past there has been a lot of work in an area of Corporate Governance. Some crucial steps include -

 Recognize and properly assess the strength of corporate governance with a credible management
and independent board. It is crucial to include executives from various professions. E.g.- Many
companies in India like, Tata Sons, IOCL have people from academic background as their board
of directors.
 Control environment refers to the overall operating style of the board with respect to their
awareness, knowledge of the members and balance of power. Contextual experience refers to the
varied experiences of the board members, e.g., how many multinational organizations they have
worked with, what have been their past experiences regarding critical situations etc. (Cohen,
Krishnamoorthy & Wright 2002)
 Levitt advocated the importance of the Audit Committee with these lines- “Qualified, committed,
independent and tough-minded audit committees represent the most reliable guardians of the
public interest”. In brief, an audit committee with good knowledge and accountability would be

(Turley & Zaman 2004) suggested the following benefits of having a sound Audit Committee):
  Structural Incentives in the form of reduction in Agency Costs i.e., managers who act as agents
can help bring better incentives to the company. E.g.- Good managers would ensure minimum
leverage if there has not been substantial growth in the business, etc.
 Improvement in Audit function by aiding the selection of potential auditors. Having a sound audit
committee would ensure selection of a responsible auditor, adequate number of reporting and
meetings. Prior research has found that there is more interdependence between the members.
 Recent studies have shown that with improvements in financial reporting, the chances of
fraudulent activities are reduced. Moreover, having a smaller number of grey directors (more of
an insider) is a positive to this.
 Several studies have indicated positive effects of the Audit committee on a company's overall
performance. Notably, a regular phenomenon to this is when we see a company’s stock price
picking up or losing as soon as a new Board is elected, or a new CEO is appointed.

Promote Organizational Justice

Organizational Justice derives itself from the Equity Theory of motivation which simply means
“Fairness in the workplace”.

 Distributive Justice: In this case, the CEO and CFO persuaded and justified their high
remuneration and bonus which indicates simply going by judgements based on a feeling. Instead,
a more rational and calculative approach can give better justification. E.g.- In the investigation it
was found that both CEO and CFO had taken $170 million worth loans using their influential
position. The total amount of money taken from Tyco was found to be a whopping $600 million.
 Procedural Justice: This talks about “How” the decision regarding any pay has been fair. If the
stakeholders are involved in the decision process it would create a sense of control and
empowerment. CEO Dennis had tried to justify his spendings in the second trial, but they were
found to be inappropriate in the court of law. Had this been raised in a systematic manner during
Board meetings, the amount of unjust spendings would not have taken place.
 Informational Justice: It is important to develop a culture of providing appropriate explanations
to any key decisions or organizational matters. When the duo took money from the shareholders,
had there been an independent audit committee, they could have reported and even raised the
issue timely.
 Interpersonal Justice: It is also important to see whether the stakeholders are being treated with
respect and dignity. In the case of Tyco, if the information regarding the meetings and spendings
would have been communicated to the executives via any quarterly report, then the red flags
could have been raised even from the bottom of the organization.

Executive Coaching
An outside executive coach who is trained and certified (ICF member or Marshall Goldsmith Certified
Coach) is asked to engage with the leaders or potential leaders within the organization. A contract is
established between the coach and coached. The discussion remains confidential as per the contract. In
the regular sessions that happen, the coach puts forward some intriguing questions and leads the coached
towards insightful discussions. Based on the coach’s certification there are many methods like GROW,
Socratic approach, Harvard coaching styles etc.

Results: The one-on-one interaction with the top management leader on a regular basis can be helpful in
raising the ethical standards. Studies have found that coaching would raise the self-awareness, expand
broader vision, challenge the unconscious beliefs which could create barriers to furthering growth and
creation of better ideas for executing innovative ventures. In the recent past, it is also being applied at
managerial level within many organizations.

Conclusion
This report provides an overview of the events that went down at the time of Tyco’s Corporate Scandal. It
highlights how personal greed and power can make or break a future of a company. Dennis Kozlowksi
(CEO) was the main character that played a crucial role in the scandal. The fraud committed by top level
management and neglecting shareholder’s interest. The report highlights the major ethical issues involved
in the scandal and the need to ponder over the facts to avoid such circumstances in future. This incident
led to thinking among government officials to protect the stakeholders’ interest and avoid future financial
fraud and misconduct. In the aftermath of this scandal, the Sarbanes-Oxley Act 2002 came into effect
which reformed the reporting requirements of the public companies to the investors.
References
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of management and governance, 8(3), 305-332.

 Cohen, J., Krishnamoorthy, G., & Wright, A. M. (2002). Corporate governance and the audit
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 Shivdasani, A. (1993). Board composition, ownership structure, and hostile takeovers. Journal of
accounting and economics, 16(1-3), 167-198.

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 SEC Brings Settled Charges Against Tyco International Ltd. Alleging Billion Dollar Accounting
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 https://www.financial-dictionary.info/terms/tyco-international-scandal/#:~:text=Tyco%20consented%20to
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%20York%20City.

 http://www.criminaldefenceblawg.com/white-collar-crime/breaking-down-the-tyco-international-
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