Taking Down the Lion: The Rise and Fall of Tyco's Dennis Kozlowski (25 page)

August 1999: Kendall pooling adjustment

Kozlowski’s bonus: $25 million; Swartz’s bonus: $12.5 million

September 2000: TyCom IPO bonuses

Kozlowski’s bonus: $32 million; Swartz’s bonus: $16 million

November 2000: ADT Automotive bonuses

Kozlowski’s bonus: $16 million; Swartz’s bonus: $8 million

August 2001: FLAG telecom bonuses

Kozlowski’s bonus: $8 million; Swartz’s bonus: $4 million

All of the bonuses were administered in the same way—not paid at the end of a fiscal year but calculated, paid, and accounted for as part of the deals during which they were earned. There was some uncertainty about whether this was allowable under the company’s Incentive Compensation Plan. For example, the largest bonuses of those in question were paid in September of 2000 to those involved with the TyCom IPO, a transaction that resulted in a nearly $2 billion nonrecurring gain for Tyco. The TyCom bonuses were paid at the conclusion of the transaction instead of being part of bonus calculations, approvals, and payments at the end of the fiscal year.

When he was called as a witness for the prosecution during the second criminal trial, former Tyco Director and longtime Chair of the Compensation Committee Frank Walsh testified that the Committee, under a shareholder-approved compensation plan and by the authority vested in it by the Board of Directors, had the discretion to set the length of a performance period and to pay lump-sum bonuses. Defense attorney Jim DeVita asked Walsh if under the Tyco Incentive Compensation Plan “the gain on the sale of [a] business” would be included in the “calculation of the cash bonus based on earnings before tax.” Walsh responded under oath, “As written, yes.” The defense asked for this clarification so jurors understood that bonuses could be earned and paid at any time, not just at the end of a fiscal year, and that even though they didn’t occur regularly, the company’s gains from IPOs and similar transactions were definitely part of Tyco’s bonus plans.

Mr. DeVita:
[I]f, for example, a subsidiary of the company issues stock and sells the stock to the public, and the company [realizes] a gain and earnings on that sale of stock to the public in the initial public offering, that also would be included in earnings before tax under this definition, correct?

[
Assistant District Attorney]
Mr. Scholl:
Objection.

The Court:
I’ll permit the witness to answer if you can.

[
Mr. Walsh
]: You talking with intent or literal interpretation—

Mr. DeVita:
What the plan says.

[
Mr. Walsh
]: As written I believe you would be correct.
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Calculations of Incentive Pay

According to the Incentive Compensation Plan (the Plan) that was approved by the Tyco Board of Directors, the Compensation Committee, and Tyco shareholders, both Kozlowski and Swartz were to receive pay-for-performance based on relatively simple mathematical calculations. One of the three prongs of the Plan provided that if the company’s pretax earnings exceeded the target set by the Compensation Committee at the beginning of the relevant fiscal year, Kozlowski was to be paid 1 percent and Swartz was to be paid one-half of 1 percent of the amount by
which performance exceeded the pre-established goal. For example, assume the Committee set a goal of 15 percent growth of pretax earnings, and the prior fiscal year’s pretax earnings were $1,000,000. Before any bonuses were payable, the company’s pretax earnings would have to exceed $1,150,000 (15 percent increase over the prior fiscal year). If the company’s actual pretax earnings for the year were $2,150,000, Kozlowski received $10,000—1 percent of $1,000,000 (the amount by which the performance exceeded the goal). Swartz received $5,000—one-half of 1 percent of $1,000,000.

Another prong of the Plan worked the same way; if the company’s operating cash flow exceeded the targets set by the Compensation Committee, 1 percent of the overage went to Kozlowski, one-half of 1 percent to Swartz. The third prong involved application of a similar mathematical formula based on whether the company’s earnings per share (EPS) exceeded the target set by the Compensation Committee.
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The performance goals were the responsibility of the Directors who sat on the Compensation Committee; they set the goals for each of the years in question.

During his summation at the end of the second trial, Swartz’s lead defense attorney Charles Stillman reminded the jury of evidence that was presented through witness testimony and with documents admitted throughout the trial. Stillman said, “The [Incentive Compensation] Plan also allowed the directors to make early payment of bonuses and to pay bonuses in forms other than cash and stock only with the consent of the employees receiving the bonuses.” Stillman also reminded jurors that after the Plan came into effect, “the first change that the directors made was to remove the cap on what bonus amounts could be received by Dennis Kozlowski and Mark Swartz.”
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In other words, bonuses were payable at any time and there were no caps on the amounts Kozlowski and Swartz could earn under the Plan.

Testimony from witnesses during the trial confirmed that the provisions of the Plan applied to nonrecurring gains from transactions when Tyco sold a business or common stock—like the gains Tyco experienced with the TyCom IPO, the sale of ADT Automotive, and the FLAG transaction. Nonrecurring gains had been part of incentive pay calculations at Tyco for many years—from the first year the plan was adopted by the Tyco Board. Under oath, SVP of HR Patty Prue acknowledged that one-time gains were included in bonus calculations, as did two former Chairs of the Compensation Committee, Frank Walsh and Stephen Foss. For example, Tyco sold Futuro in 1996, when Richard Bodman was the Chair of the Compensation Committee, and bonuses were paid on that gain. The same was true in 1999 when Tyco sold two large companies and experienced nonrecurring gains. Bonuses were paid on those gains, as part of the transactions. Not at the end of a fiscal year.
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The issue, then, was not whether Kozlowski and Swartz had earned the bonuses or whether the company could or should pay the bonuses. Under the Plan,
the bonuses were payable to Kozlowski and Swartz. The crux of the grand larceny charges related to the bonuses was whether the Board of Directors
authorized
payment of the bonuses—a step required by the Plan.

The TyCom IPO

TyCom was part of Tyco’s undersea cable unit. In 2000, Tyco raised almost $2 billion by selling 11 percent of TyCom in an IPO. Tyco acquired TyCom for $750 million and as with hundreds of other companies, Tyco implemented cost reductions and revenue enhancements that transformed TyCom into a more valuable enterprise. After the IPO, Tyco still owned 89 percent of the subsidiary and in addition, realized a substantial nonrecurring gain.

When he took the stand in his own defense during the second trial, Kozlowski explained how and why the TyCom bonuses were paid in September of 2000. Kozlowski told the jury, “Tycom [
sic
] was an acquisition Tyco did a number of years before and we took the company public. That is we sold about 11 percent of Tycom for about one point nine billion dollars. Our investment in Tycom or what we paid for Tycom was about 750 million dollars and had some other investments in the company; but this resulted in a very, very large gain for Tyco. By taking it public we made a separate company out of it. Tyco owned 89 percent of the company but shareholders owned the other 11 percent and it traded on the New York Stock Exchange. Tyco booked the large gain and that became part of our performance under the bonus formula for that fiscal year.”
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Kozlowski explained discussions about the TyCom deal he had with Phil Hampton, then the Chair of the Compensation Committee. Kozlowski said:

I believe it was August of the year 2000 that I informed Phil [Hampton] we were going to take a very sizeable gain in Tycom, and Phil was in the loop on this because he was following the Tycom sale all the way. He would call me almost on a daily basis and say what is the interest in Tycom or are people going to be buying this deal, and we responded in the affirmative that it looked very good for us over the two week period we were out, we would be telling management and employees of Tyco and Tycom to sell this deal; and as a result I explained to Phil that—well, first I went to Mark [Swartz] and asked Mark to calculate what kind of bonus does this big gain mean to us, and Mark gave a range of a phenomenal number, something of about 60 to 65 million dollars on my behalf. That meant Mark would be receiving about half of that because typically Mark’s compensation the way it worked was 50 percent of mine and I had further discussions with Phil about my feelings on that size bonus. I suggested that as opposed to taking 65 million dollars in a cash bonus or deferring it or doing whatever we would be then doing with the bonus, we cut my bonus in half and Mark’s bonus in half and we use the
remainder of those, of the bonuses earned here to reward other people in Tyco who were instrumental in the Tycom deal; that is people who primarily—we were thanking people who moved from Exeter, New Hampshire to Boca Raton, Florida that we reward them in a very special way.
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After Tyco’s acquisition of ADT in 1997, most of Tyco corporate headquarters was relocated to Boca Raton, Florida, where ADT was located at the time the two companies merged. Kozlowski wanted to reward the employees who were asked to relocate from New Hampshire to Florida, and who played crucial roles in the successful TyCom IPO.

Kozlowski told the jury: “You have to keep in mind 1999 and 2000 were spectacular years for us. Our stock was going up I believe some 50 percent a year. Tycom was considered to be a very successful acquisition, a very successful acquisition and resale within a short period of time, and my intention or my plan was that I told Mark, was that the 50 or so employees who relocated from Exeter, New Hampshire that we forgive their home mortgages as part of a special bonus for monies that they borrowed to come to Boca Raton, Florida. We would forego a portion of our bonuses in order to reward other people who were critical and very important members of our team.”
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“Since I was asking Phil for half the amount due to me [under] the formula,” Kozlowski said, “I suggested to Phil that he communicate with . . . whoever he had to communicate with. He said he would handle that and I also told him that we would have any information. . . . Patty Prue would have the details as we worked this out and Patty was the liaison to the Compensation Committee and he to Patty.” Kozlowski explained that he consulted with both Prue and Swartz as they planned the TyCom bonus and testified, “I’m certain I had meetings with them to discuss the bonus. I certainly met with Mark because Mark went along with the program of reducing his bonus by 50 percent as I did.”
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In explaining the decision to pay down employees’ relocation loans instead of paying cash bonuses, Kozlowski said that “[w]e ‘forgave’ loans only in lieu of paying cash bonuses. If I or someone earned a bonus and had an outstanding loan, the loan would be paid (i.e., forgiven) rather than a check being issued.”
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When asked how much he ultimately received as part of the TyCom bonuses, Kozlowski said, “I believe it was instead of the 64 million dollars, it was approximately 32 million dollars.” Kozlowski explained that his bonus was not paid in cash but instead was used to reduce the outstanding balance of the loan he took when he relocated to Boca Raton, Florida. He had taken the loan through Tyco’s relocation loan program, a generous benefit that was available to and used by many employees, not just those at the executive level. Kozlowski told jurors, “Well, 19 million dollars of the bonus was loan forgiveness and the remainder was taxes.” When asked if the $19 million paid off his relocation loan in its entirety, Kozlowski said,
“At the point in time after I paid off the relocation loan with the formula bonus, I believe I still owed about five and a half million dollars on my Florida relocation loan.”
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It’s surprising that Kozlowski, if he was intentionally stealing from the company, didn’t steal enough to completely pay off his outstanding loan.

Kozlowski said that his bonuses from nonrecurring gains had been calculated and paid in the same way since he was a Tyco division president. He explained:

If we sold a building or sold a business or sold an asset, the profits on that would become part of our bonus formula. It was the only reasonable way to give management the incentive to sell assets that should be sold, if not, we would keep the asset, allow them to continue to . . . generate income, and you would continue to get a bonus on the stream of income from those assets. If strategically or operationally or emotionally or for whatever reason selling off a business was the right thing to do, the gain between the book value of that business and the selling value of that business was, always has been, any incentive system I ever had at Tyco, part of my bonus calculation. There is precedence for that when we sold the Muller business, sold the Grinnell business at Tyco, sold Futuro, this was in years prior to the Tycom bonus, and gains were all part of our bonus calculation and formula, and always had been.
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When head of HR Patty Prue testified, she too was asked about the bonuses. Prue was one of the forty-two employees on the list of recipients of TyCom bonuses in September of 2002; she received $1,269,396.74. The bonuses ranged from a low of $318,636.28 to a high of $32,976,067.85. Nine of the bonus payments exceeded $1 million. Kozlowski’s memo announcing the bonuses along with the list of recipients was circulated to a number of people in the company including Mark Foley, who at the time was Tyco’s SVP of Finance. In addition to Kozlowski’s memo, many other documents and entries were created to announce, process, and account for the bonuses. Kozlowski did not calculate the bonus amounts. He said, “I spent zero percent of my time calculating bonuses.”
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