Taking Down the Lion: The Rise and Fall of Tyco's Dennis Kozlowski (15 page)

In an opinion based on the clearest findings of fact and what is very likely the most legally sound reasoning found among the dozens of court decisions that emerged from the Tyco scandal, Judge Cote ruled for Frank Walsh in Tyco’s civil action against him. The court described accurately that “[m]any board members were deeply distressed to learn that a payment of this magnitude had been made by Kozlowski to a director, but the board took no other steps at the meeting either to ratify the payment or to seek its return.”
37

The court found that “[a]s a fiduciary to Tyco, Walsh had a duty to disclose to Tyco’s board that he stood to benefit personally from its approval of Tyco’s acquisition of CIT. Indeed, § 64(7) of Tyco’s Bye-Laws requires directors of the company to disclose potential conflicts of interest to the board,” and Judge Cote held that “[a]lthough Walsh breached his fiduciary duty by failing to disclose his receipt of the $20 million payment, Tyco’s board implicitly ratified his breach. It did so through its public filings and statements signaling approval of the payment, as well as its failure to seek return of the payment until months after learning of it.”
38
In a succinct and accurate summary, the court opined:

In 2001, when Tyco paid Walsh and his designated charity $20 million in connection with the acquisition of CIT, Tyco’s Bye-Laws permitted its board “to grant special remuneration” to a director who “perform[s] any special or extra services” for Tyco. No later than the January 16, 2002 board huddle, Tyco’s directors possessed “full knowledge” of the relevant facts—the circumstances of the payment to
Walsh and the amount of the payment. Fully informed as to the relevant facts, the board members presented Walsh with a choice: he could return the payment, or he could keep the money and leave the board. Walsh chose the latter course of action. For all he knew when he left the January 16 huddle, the board had allowed him to keep the money on the condition that he resign as director. Indeed, the board did not take any action after Walsh left the huddle other than refusing to permit Walsh to be re-nominated to serve on the board at the upcoming shareholders meeting. No mention whatsoever of the payment was made at the official board meeting held on January 20, just a few days after the board huddle at which the payment was discussed with both Walsh and Kozlowski. Further, Tyco’s proxy statement disclosing the Walsh payment, filed promptly after the board learned of the payment at its January 16 huddle, contains no statement that the board disapproved of the payment or was seeking its return. Nor does it reveal that the payment was only reported to the board after it had already been made. Rather, the only reasonable reading of the disclosure is that both the company and the board found the payment to be appropriate under the circumstances; the proxy statement reports that Walsh was “instrumental in bringing about the acquisition” of CIT and that the $20 million payment was made in return “[f]or his services” in the transaction. If the board had any reservations about the legality or propriety of the payment, then it would have been expected to disclose those reservations in the proxy statement, for instance, by indicating that it had begun an investigation of the payment and the appropriate course of action to be taken to recover it.
39

The court pointed to express statements made by then Director Josh Berman: “Berman’s statements in February 2002 in defense of the wording of the proxy statement confirm that the board implicitly ratified the payment. Berman told Belnick that he was trying to ‘steer a middle course’ in which ‘the Board just doesn’t ratify, doesn’t not ratify.’ In other words, the board’s press releases and SEC filings would suggest to the public that the board approved of the payment, but the board would not pass a resolution expressly confirming the payment. This is the very definition of implied ratification; the board’s actions suggested its approval of the Walsh payment without expressly confirming it.”
40

The court was confident that the Board didn’t do anything until May of 2002 and that its action in May was “best seen as a reaction to the firestorm of negative publicity that was descending on Tyco” at that time. The court identified the former Directors’ revisionist history and stated that “[t]hese after-the-fact assertions are insufficient to overcome the historical record that in January 2002, with full knowledge of the payment, the directors decided not to pursue recovery. . . .”
41

Following a bench trial (where the judge acts as both judge and jury) on October 12 and 13, 2010, all of Tyco’s claims against Walsh were denied.
42

Part Three

Ring around the White-Collar of Criminal Justice

Former Manhattan District Attorney Robert Morgenthau was long-known for his pursuit of white-collar criminals. Morgenthau said, “It’s very important that the government doesn’t go after only people who rob convenience stores. I made a point of going after people in positions of power and trust. The law applies to everyone. That’s the message I wanted to send.” More than a decade after he charged Tyco executives with serious crimes under New York State law, Morgenthau explained his decision to prosecute Dennis Kozlowski and Mark Swartz. He said, “It sent a message to a lot of people. You can’t conceal information and get away with it.”
1

Robert Morgenthau was the inspiration for Manhattan District Attorney “Adam Schiff” on the long-running Dick Wolf television drama
Law & Order.
Morgenthau outlasted his fictional counterpart’s tenure by decades. Morgenthau held the office from 1974 until he retired in 2009 at the age of 90. After leaving public service, Morgenthau along with his personal assistant of nearly 40 years, Ida Van Lindt, joined the New York law firm Wachtell, Lipton, Rosen & Katz on West 52nd Street in Manhattan.

Thirteen

“
Pour encourager les autre
s
”

The Art

Dennis Kozlowski’s foray into the world of fine art proved to be one of his biggest mistakes. Kozlowski said he met art dealer Christina Berry on a Saturday afternoon in the summer of 2001 at the home of Bill Koch in Palm Beach, Florida. Berry worked for Fine Collections Management, a company that served as agent for wealthy clients interested in purchasing fine wine and expensive art. Kozlowski found out much later that Fine Collections Management was owned in part by Koch—something Koch didn’t disclose when he invited Kozlowski to meet the art agent.
1

Three Paintings for Tyco: $1.975 Million

In the summer of 2001, Berry helped Kozlowski and his wife select paintings for the Tyco apartment at 950 Fifth Avenue in New York. On behalf of the corporation, Kozlowski authorized the purchase of three paintings from the Richard Green Gallery in London in August of 2001 for a total price of $1.975 million (plus eight percent and an hourly fee for the services of Christina Berry). The paintings were hung in the apartment in September of 2001 and the invoice for the painting was sent to Tyco. As with real estate broker Dolly Lenz and the purchase of the 950 Fifth Avenue apartment, Berry testified in Kozlowski’s criminal trial that she was unaware the paintings were purchased by Tyco; she considered Kozlowski and his wife her clients. Of note, Christina Berry was granted immunity from prosecution when sales tax on the purchase wasn’t collected and remitted. Her testimony must be viewed in that light. Tyco employees confirmed during the criminal trials that the three paintings were recorded as assets on the books and records of the corporation, and the transaction was handled by individuals at Tyco other than
Kozlowski and CFO Mark Swartz—the purchase was not concealed. Evidence admitted during the trials proved the paintings hung in the Tyco-owned apartment and remained there after Kozlowski was ousted from Tyco in June of 2002.
2

Four Paintings for Dennis Kozlowski: $8.8 Million

In December of 2001, Berry arranged for paintings from the Richard Green Gallery to be shipped to Kozlowski’s home in Florida for his review. Kozlowski chose to purchase four of the paintings for a total of $8.8 million (plus, for Berry’s services, an eight percent commission and an hourly fee). The invoice was sent to Tyco, but these paintings were for Kozlowski personally, not for the corporation. During his second criminal trial, Kozlowski produced a promissory note he signed on December 19, 2001 showing that he borrowed funds through Tyco’s Key Employee Loan Program (KELP) to pay the entire $8.8 million bill. When asked on the stand if he repaid that loan, Kozlowski testified, “Yes, I paid that loan back to Tyco.”
3

A Monet for Kozlowski: $3.95 Million

In early December of 2001, Berry also arranged for Kozlowski to view a Monet painting that was at the Alexander Apsis Gallery at 930 Fifth Avenue in New York. Apsis brought the painting to the Tyco apartment for Kozlowski to view, whereupon Kozlowski agreed to pay $3.95 million (plus eight percent and an hourly fee for the services of Christina Berry) for the Monet. He made the purchase on January 3, 2002; Kozlowski signed another promissory note when he borrowed $3.95 million through KELP to pay the Alexander Apsis Gallery for the painting. When asked in court “Did you pay it back?” Kozlowski replied under oath, “Yes, I paid that back.”
4

Bra
gg
ing Rights: Pricele
ss

Kozlowski said he hosted a fundraising event for the Christopher Reeve Spinal Cord Injury and Paralysis Foundation in the 950 Fifth Avenue apartment soon after he made his first serious art purchases. “I bought the paintings and had them hung in the apartment before the event,” he said. Kozlowski planned to move the pieces he owned personally to his home in Florida, or possibly to a home in another city after Tyco split up. Considering the company’s plans at the time, Kozlowski believed he may be working out of another location and that Tyco would likely sell the Fifth Avenue apartment in the coming months. Kozlowski’s pieces of fine art never made it to his home.
5

During a 2008 interview he gave in the Mid-State Correctional Facility to Swiss reporter Peter Hossli, Kozlowski was asked why he wanted to buy a Monet and a
Renoir. Kozlowski replied, “It was more about bragging rights than anything else. I wanted to be an important art collector quickly. That was ridiculous. I know it and I regret it.” Kozlowski admitted that the sole purpose for hanging the paintings in the Fifth Avenue apartment was to impress the rich and famous attendees of the charity event with his expensive collection of fine art. He learned the hard way that pride goeth before a fall.
6

New York Sales Tax

In the State of New York, there is an 8.25 percent sales tax on the sale of tangible personal property in the state and in the alternative, a compensating use tax.
7
According to the New York State Department of Taxation and Finance, “New York State and local sales taxes are imposed on taxable property and services purchased or delivered to you in New York State. In most instances, when you purchase a taxable item or service in the state, or if it is delivered to you in the state, the seller will collect sales tax from you. The seller then pays the tax over to the Tax Department.” Within the City of New York, vendors are obligated by law to collect the taxes or in the alternative, purchasers are to pay the taxes.
8

New York sales tax or use tax is due when New York personal income tax returns are due. According to the Department of Taxation and Finance, “Failure to pay tax you owe by the due date may result in the imposition of penalties and interest, or both.”
9

The Wrong Solution

On April 25, 2002, Tyco announced that it was no longer going to split the company into four separate businesses—backpedaling from plans outlined three months earlier.
10
In a letter to Tyco shareholders, Dennis Kozlowski explained the about-face:

Our rationale for the break-up plan was based on a simple premise. Despite superior growth in earnings and cash flow, Tyco was being valued at a significant discount to its peers. Among the reasons for the discount was the market’s unease with highly complex companies that are in multiple business lines with few obvious synergies. By splitting up the company, we saw an opportunity to address these concerns and accelerate the creation of value for our shareholders. But we know now it was a mistake, and it is time for us to return our focus to what we do best.

While our goal in changing the strategy was to do right by our shareholders, we came up with the wrong solution. In retrospect, it is now clear that we took the market by surprise with our announcement, and failed adequately to take into account the extraordinarily fragile market psychology and hostile environment
that has distracted and damaged our business in recent months. We compounded the problem by delivering some incremental bad news, especially lower earnings expectations tied to both the distraction as well as the continued downturn in the electronics and telecom industries. As your chief executive officer, I take full responsibility and am aware that Tyco’s management has let you down.

Having said that, it’s been upsetting to see inaccurate reporting and unsubstantiated rumors about Tyco given such a public platform. As stewards of a public company we know we are subject to scrutiny every day and the current climate is one in which all companies are under a microscope. We have always tried to be as transparent in our accounting as possible. Indeed, I consider our disclosure to be second to none among our peer companies. That some in the media would compare us to companies that may have intentionally misled investors through the use of financial chicanery is insulting and inaccurate. To be thrown into stories about “accounting scandals” damages our reputation and casts aspersions on our employees. Yes, critics have raised questions about our accounting, which is why we initiated weekly conference calls to address questions from analysts, investors, and even short-sellers who benefit from a stock’s decline. We took all questions asked and didn’t shy away from answering them. While we’ve tried to address the inaccurate reporting, of primary concern to me is how we communicate to you, our shareholders. That’s one reason why I am writing to you today.

Right or wrong, one thing is certain: we pursued the break-up plan because we believed it was the best way to unlock value for our shareholders. As anyone who has invested in Tyco over the past decade knows, that is the principle that guides every decision we make. It guided our decision to break up the company. And now, as circumstances have changed, it is guiding our decision to keep it together and take the break up off the table—and to change the way we operate in certain fundamental ways.
11

Kozlowski tried to reassure shareholders by reminding them of Tyco’s long history of growth and solid performance. He wrote:

Let’s not forget that we have one of the best track records of companies our size when it comes to delivering shareholder value. According to the
Wall Street Journal’s
annual shareholder scoreboard, Tyco delivered average annualized returns of 30.5% for the 10 years ending December 31, 2001. That’s the exact same figure the Journal cited for Microsoft’s returns over the same time period. We can’t lose sight of the enviable performance of this company over the years. Even including this year’s decline in the share price, over 10 years the Company’s total return is 535%, compared to the Standard & Poor’s 500 stock index return of 225%. During my tenure as CEO, we have increased our cash flow per share by 29% annually and our earnings per share by 27%.

Kozlowski closed the letter with a personal note:

The past few months have been difficult for Tyco’s shareholders and employees. For me personally, they have been the most difficult of my career. But the issues are temporary and solvable. I am proud of our workforce. Despite the distractions, the men and women who have made Tyco a great company have proven to be resilient and remain committed to delivering quality services and products to our valued customers.

We know we have some work to do if we are to regain your trust and confidence—and we are committed to returning Tyco to the track of superior performance and shareholder value creation that it delivered in the past decade. Our watchwords for the future are performance, communication and execution.
12

* * *

The calendar changed from April to May and the difficulties of 2002 continued; life at Tyco did not improve. The company still needed to divest CIT and was dealing with the challenges presented by its recently downgraded credit ratings. While the decision to scrap plans to split up the company received mixed reviews in the market, there’s no doubt that management’s apparent indecision invited even greater scrutiny. According to Brad McGee, “It was an extraordinary time and Tyco was easy to attack because we were a large company with a lot of moving parts. Everyone had just watched other large companies skyrocket and then flame out.” He explained, “Because of our size, our financial reporting was unavoidably complex and even though we were completely confident in our accounting and disclosures, and even though we communicated constantly with our shareholders, the attacks kept coming. With all of the uncertainty, a lot of shareholders got out and waited to see what happened.”
13

The company’s stock (TYC) price reflected the struggles of the first four months of what had become the year from hell for Tyco and Dennis Kozlowski. On May 1, 2002, TYC closed at $28.21. A year earlier, it had closed at $74.18.
14

The Indictment

Sometimes when it rains, it pours. On top of the business concerns that consumed his life twenty-four hours a day, seven days a week, Dennis Kozlowski learned in May of 2002 that he was somehow involved in a sales tax investigation being conducted by the Manhattan District Attorney. “I thought I was on the periphery of an investigation of one of the galleries that sold me art, or of a dealer who sold me art,” Kozlowski explained. “I turned it over to my attorney and asked him to handle it. I had no idea
I
was being investigated.”
15

“At around 2 o’clock on Friday afternoon the weekend after Memorial Day, I received a call from my attorney Stephen Kaufman,” Kozlowski recalled. That telephone conversation was one of the most shocking of his life. “He informed me that the Manhattan DA was going to indict me on sales tax evasion charges related to art that I purchased. He told me I was going to be indicted the following week.” Kozlowski said, “But Stephen said ‘Don’t worry—don’t worry about it. I’ll never let it bring you down.’”
16

Kozlowski was in his office in Boca Raton on Friday May 31, 2002 when he received Kaufman’s call. “I didn’t know when I left that evening,” he said in a voice that after more than a decade was still heavy with shock and grief, “that I would never again return to a Tyco office.”
17

Even though the sales tax charges were a personal matter, Kozlowski was the CEO and Chairman of the Board of a huge publicly traded corporation. He was fully aware that he had to address his personal troubles with the Tyco Board. Because of his position, the company and its shareholders had an interest in any personal legal issues he faced. On Friday evening after he left his office, he spoke to Tyco Chief Corporate Counsel Mark Belnick, and over the weekend of June 1st and 2nd, Kozlowski called all of the Directors to inform them of the forthcoming indictment. Kozlowski recalled that Josh Berman told him he would have to step down because “there was too much mud on the windshield.”
18

Kozlowski said, “On Sunday I flew to New York. I spent the evening and well into the night on the phone with Stephen Kaufman. At around midnight,” Kozlowski recalled, “I heard from Stephen Kaufman who heard from David Boies [the attorney the Board hired] who supposedly heard it from the Board—I was out. There was no Board meeting, there was no vote, they didn’t speak with me, they didn’t even give me a chance to explain or to gather additional information about the charges in the indictment. It was over. I was out.”
19