Accounting, Business, Law, Management

Tyco Corporate Scandal of 2002 (Ethics Case Analysis)

Updated on Updated on by Jonathan Romero
Tyco ethics case study, 2002 corporate scandal, Kozlowski motivation, tax avoidance, commingling assets, Board of directors
A Tyco vehicle. The Tyco corporate scandal of 2002 involved problems in business ethics among top officials of the company. (Photo: Public Domain)

Tyco International’s corporate scandal of 2002 involved systemic issues and ineffectiveness linked to unethical and illegal business practices. This business case considers how ethical problems have the potential to bring down an entire organization. Tyco International (now known as Johnson Controls International plc) was a large security systems organization that grew through numerous acquisitions. The company’s case shows that the main problem was the unethical business practices of some of its top-ranking officers, especially CEO Dennis Kozlowski. Kozlowski was involved in questionable financial transactions that were not included in the company’s financial reports. He enlisted the help of other Tyco officers and lower ranking employees to cover up for illegal financial transactions. Moreover, Kozlowski expanded the problem when his second wife received money diverted from the company. Court proceedings proved that he stole millions of dollars from Tyco, and that his illegal financial transactions were extensive. Kozlowski and CFO Mark Swartz were convicted and imprisoned in 2005. In the aftermath of the scandal, Tyco’s business performance declined, and investors lost confidence in the company.

This business ethics case of the Tyco corporate scandal of 2002 presents how a large organization could suffer from the unethical and illegal actions of employees and external parties. The motivations beneath such actions and the issue of commingling assets are relevant in this case, along with the importance of the board of directors, such as in monitoring business operations and the activities of Tyco’s executives, like Dennis Kozlowski and Mark Swartz.

Ethics Issues in Tyco’s Case

The Tyco scandal shows that ethics issues can occur in various aspects and components of an organization, including the top corporate leadership. Leaders and executives trusted by stakeholders and with seemingly commendable backgrounds could exhibit unethical behavior and facilitate unethical and illegal practices that harm the business and its stockholders. Considering Kozlowski’s activities, outsiders or third parties could get involved in these ethical problems. Thus, codes of ethics and regular assessments of the business must apply to all employees at all organizational levels, and to third parties or external players, such as accounting and auditing firms. The main ethics issues in Tyco’s case were as follows:

  1. Unethical Leadership
  2. Unethical business practice of subordinates
  3. Questionable auditing practice on Tyco’s business

Unethical Leadership at Tyco. Dennis Kozlowski was at the center of the unethical activities in the business organization. As the CEO, he committed unethical practices that led to the legal battles and related financial problems of Tyco. Kozlowski, the main actor in this case, was the primary recipient of the money stolen from the company. He used his position as CEO to persuade other top-ranking Tyco officers and lower ranking employees to get involved and turn a blind eye to his questionable and illegal activities. This case illustrates that the involvement of Kozlowski and other employees was a major factor that contributed to the Tyco scandal. Although factors like organizational culture affected the events in this case, leadership was a critical factor that facilitated the occurrence of the corporate scandal.

Unethical Business Practice of Subordinates. The complications in Tyco’s case involved people other than Kozlowski. Kozlowski recruited the support of CFO Swartz, another high-ranking officer in the organization. Members of Tyco’s board of directors were also involved. For example, a board member kept silent about the purchase of a mansion for Kozlowski and his wife. In exchange, this board member received financial benefits, either directly or indirectly. In addition, Kozlowski convinced some lower ranking employees to keep their silence, also in exchange for financial benefits.

Questionable Auditing Practice. The auditing firm, PricewaterhouseCoopers (PwC), responsible for checking the financial reports of Tyco, failed to identify Kozlowski’s illegal financial transactions. PwC was accused of not exercising due diligence in verifying the financial reports. As a result, Kozlowski’s unethical business practices continued, leading to the involvement of various personnel in Tyco’s organization. These practices became difficult to stop because of the absence of constraining influence from the auditing firm.

Kozlowski’s Motivation for Avoiding Sales Taxes on Art Purchases

One of the points highlighted in the Tyco corporate scandal was the case of Kozlowski’s tax evasion, such as in purchasing art worth millions of dollars. While his actual motives in evading taxes were not fully established, it can be argued that avoiding taxes were based on (1) materialistic greed and (2) avoidance of raising a red flag regarding his illegal activities at Tyco. In the lens of business ethics and corporate governance, these factors could be the root causes of even more problems in the security systems company.

Kozlowski’s materialistic greed focused on financial or material gains using his position as the CEO of Tyco. For example, his unethical activities, including questionable executive loans, were all for the purpose of gaining (or stealing) as much money as possible from the security systems company. Court proceedings also determined that Kozlowski has a history of tax evasion that occurred prior to the start of investigations into the corporate scandal at Tyco. Based on these illegal activities, it is established that Kozlowski prioritized his personal material gains, and he did not properly consider ethical conduct and the interests of the company’s shareholders.

Tax evasion was among the ethical issues in this case. The most popularized instance involved Kozlowski’s purchase of artwork, for which empty crates were sent to Tyco’s New Hampshire address to avoid taxes in New York. It can be argued that these tax evasion instances were intended to avoid raising red flags that authorities could use against Kozlowski’s other illicit activities at the company. For instance, sales taxes would create formal records of these transactions, which would link him to accounting irregularities at Tyco. With such records, it would have been easier for authorities to detect Kozlowski’s illegal transactions because it is unusual for Tyco to provide financial support to officers, like Kozlowski, for personal purchases amounting to millions of dollars.

Commingling of Assets in Tyco’s Case

The concept of commingling of assets refers to the mixing of personal assets and company assets. In this case, commingling occurred on multiple occasions, such as when Dennis Kozlowski used Tyco’s funds for his wife’s birthday party. Commingling of assets also happened when the company’s money was used for personal purchases, such as the purchase of houses and artwork for Kozlowski and his wife. In a way, the former CEO unethically viewed Tyco’s money as part of his own personal assets.

This case of Tyco’s corporate scandal illustrates that commingling of assets made it easy for Kozlowski to use the company’s assets for personal needs. It is worth noting that the company had programs that had loopholes, which enabled the unethical use of assets for personal gain. For example, without adequate monitoring and oversight, Kozlowski exploited the company’s existing programs for executive loans and other funding. In this regard, this case was not just the stealing of Tyco’s funds. It was also an exploitation of the weakness of the company’s financial program loopholes during Kozlowski’s time as CEO.

The Board of Directors and Questionable Adjustments to Tyco’s Programs

A company’s board of directors is entrusted with investors’ money, such that every director has responsibility and accountability in ensuring that the company’s funds are legally and properly used. In this case, Tyco’s board of directors had the responsibility to prevent the occurrence of illegal activities, like those of Dennis Kozlowski. The directors had the opportunity to examine the company’s finances and identify questionable transactions, even when Kozlowski and his accomplices tried to prevent board oversight. A proper ethical mindset was necessary to drive the directors to fulfill their roles in Tyco’s business organization.

Dennis Kozlowski exploited Tyco’s programs, such as the Key Employee Loan Program, which was designed to help executive officers pay taxes on their stock options. However, as this corporate scandal case illustrates, such programs were a weakness that created opportunities for unethical conduct. For example, former CFO Swartz modified the program to allow top executives to take out loans for purposes other than paying taxes on stock options. Through this change, Kozlowski and Swartz were able to take out loans for personal gains. Such unethical business practices could have been prevented if Tyco’s board of directors fulfilled its roles and responsibilities. The directors should have examined the appropriateness of these programs and any loopholes that could be used for illegal transactions. The board of directors also had the opportunity to assess Kozlowski’s decisions and strategic plans to identify possible red flags. In this regard, the ineffectiveness of the board of directors in properly evaluating Tyco’s programs was a factor that contributed to the corporate scandal involving Kozlowski, Swartz, and other employees.

References

Tags: , , ,