In June 2005, Dennis Kozlowski, former CEO of Tyco, was convicted of charges involving grand larceny, conspiracy, securities fraud, and falsifying business records. He was sentenced to ten years in prison for his crimes against the company. Prosecutors stated that Kozlowski stole more than $150 million from the company by increasing his salary for performance bonuses without board approval and by borrowing money from the company and then forgiving the loans. Kozlowski claimed the bonuses had been approved verbally by a board member, but the member had died, so it was impossible to verify this statement. 2 Reports from The Wall Street Journal described Kozlowski’s actions as an attempt “to transfer massive sums of wealth to himself at the expense of shareholders.” 3

Tyco hired Kozlowski in 1976 and named him CEO in 1992, when Tyco had $3 billion in annual sales from sprinklers and packaging materials. Twelve years later, Tyco was a manufacturing and service company selling electrical components, circuit boards, undersea cable systems, fire detection systems, electronic security systems, special valves, and medical supplies 4 with sales of $40.1 billion. Kozlowski became one of the highest paid corporate executives in the country for his efforts to expand the business by acquiring new businesses and extending the reach of its current products by building a worldwide distribution system.

Richard Scalzo, a PricewaterhouseCoopers auditor, testified during the trial.

According to him, the auditors were aware of the bonuses. He believed that it was the auditor’s job to determine whether the compensation had been recorded correctly on the financial statements but not to determine whether the compensation had been authorized.5 Tyco admitted overstating income from 1998 to 2001 by $1.15 billion. 6

a. According to the auditing standards, internal control policies should include controls necessary to provide assurance that transactions are recorded so company expenditures are made in accordance with management and board authorizations and to provide assurance that unauthorized use of company assets has not occurred. Explain how Kozlowski’s policies violated internal control standards.

b. Was Kozlowski entitled to live well because under his direction the company was doing very well? If so, did he have the right to use company funds in the manner he did? Give your reasons.

c. What type of oversight should the auditors and the board of directors have exercised with regard to these expenditures? Do you agree with the Scalzo auditor’s statement that it was not the auditor’s responsibility to determine whether the compensation was authorized?