DISTRICTOFNEWHAMPSHIRE MAR2 5 2005 FILEDsecurities.stanford.edu/filings-documents/1023/TYC... ·...
Transcript of DISTRICTOFNEWHAMPSHIRE MAR2 5 2005 FILEDsecurities.stanford.edu/filings-documents/1023/TYC... ·...
UNITED STATES DISTRICT COURTDISTRICT OF NEW HAMPSHIRE
IN RE TYCO INTERNATIONAL LTD., )SECURITIES, DERIVATIVE AND )"ERISA" LITIGATION )
)EZRA CHARITABLE TRUST, )
Plaintiff, )
vs. )
TYCO INTERNATIONAL, LTD., and )EDWARD D. BREEN, )
Defendants. )
PLAINTIFFS ' CONSOLIDATED AMEN;
U.S. CD;S TRICT COURTDISTRICT OF NEW HAMPSHIRE
MAR 2 5 2005
FILED
02-MDL-1355-BSECURITIES ACTIONCivil Action No.03-1355-B
CO
Plaintiffs Ezra Charitable Trust, Mirror Management Limited and Robert Bovit allege the
following based upon the investigation of Plaintiffs' counsel, which included a review of United
States Securities and Exchange Commission ("SEC") filings by Tyco International Ltd. ("Tyco" or
the "Company"), regulatory filings and reports, securities analysts' reports, press releases and other
public statements issued by the defendants, media reports about the Company, interview with
witnesses with first-hand knowledge, and consultation with a forensic accountant. Plaintiffs believe
that substantial additional evidentiary support will exist for the allegations set forth herein after a
reasonable opportunity for discovery.
1. NATURE OF THE ACTION
1. This is a securities class action brought under Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934 (the "Exchange Act") on behalf of purchasers of the securities of
Tyco between December 30, 2002 to March 12, 2003, inclusive (the "Class Period")
2. During 2002, Tyco was the focus of intense scrutiny as revelations about its
accounting improprieties and the fraud and faithlessness of its senior executives made national
headlines. On September 17, 2002, Tyco sued (a) its former Chief Corporate Counsel' Mark A.
Belnick; (b) a former director, Frank E. Walsh ("Walsh"); and (c) its former Chairman and CEO,
Dennis Kozlowski. Tyco sued these individuals "breach of fiduciary duty and other wrongful
conduct." (Form 8-K filed 9/17/02). Tyco also sued its former CFO, Mark H. Swartz, on October
7, 2002, in arbitration, for breach of fiduciary duty, wrongful conduct and misappropriation. (Id.)
3. Walsh pleaded guilty to a felony conviction in 2002 in Manhattan Suprer+e Court,
and agreed as part of his plea to pay $20 million to Tyco as restitution and to pay other fines to the
State ofNew York. Walsh also settled a case brought against him by the SEC in Manhattan federal
court.
4. The U.S. Attorney's office in the District ofNew Hampshire, the Manhattan District
Attorney's Office and the SEC all subpoenaed Tyco for documents in 2002, as disclosed n Tyco's
2002 Form 10-K for the fiscal year ended September 30, 2002, filed December 30, 2002 (the
"September 30, 2002 Form 10-K"). On October 23, 2002, Tyco signed a consent decree with the
Bureau of Securities Regulation for New Hampshire resolving that bureau's investigation into
Tyco's senior management. Tyco paid a $5 million fine. Numerous shareholder class actiIons were
filed against Tyco in 2002 as well. (September 30, 2002 Form 10-K). After the end of the Class
Period, Kozlowski and Swartz were indicted and put on trial for fraud in Manhattan Suprenie Court.
The trial ended in a hungjury and they are subject to re-trial, currently scheduled to begin in January
2005.
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5. Thus, before the beginning ofthe Class Period, Tyco had undergone numerots highly-
publicized scandals relating to its senior executive personnel and its falsely inflated financiali
statements. To continue as a viable entity and to avoid bankruptcy, Tyco needed to assure the
marketplace that it had cleaned up its all of its accounting and financial statement problers. Tyco
had enormous debt to pay off by February 2003-some $3.855 billion-and could not have' attracted
ineeded new investment in the Company if investors believed that Tyco's financial statements were
still subject to material misststatements and fraud. Indeed, Tyco faced bankruptcy if it failel to repay
this debt and attract new investment.
6. Tyco's new Chairman and CEO, defendant Edward D. Breen ("Breen"), and new
CFO, defendant David J. FitzPatrick ("FitzPatrick"), had been brought on by Tyco in the wake of
the departure of Kozlowski and Swartz, with very generous stock incentives, large guaranteed cash
bonuses, and stock options. These served as strong motivation for Breen and Fitzpatrick to push to
obtain the needed financing to keep Tyco solvent and to ignore obvious accounting problems that
still plagued Tyco.
7. Tyco announced on December 30, 2002 -- the beginning of the Class Period -- that
its accounting improprieties and "systemic fraud" were problems in its past, and that 'Tyco was
unaware ofany clear accounting errors that would adversely affect the Company's reportedleamings
and cash flow for 2003.
8. In particular, Tyco told the public that its accounting problems were at an end at its
ADT division, Tyco's largest division and a seller of electronic security systems to home and
commercial property owners. According to SEC filings, Tyco's ADT division had previously
recognized bogus income on its financial statements in connection with fees ADT charged its
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authorized dealers in Latin America. According to Tyco, these dealer fees were imposed when ADT
purchased a customer account from its authorized dealer. ADT falsely reported these fees as
reimbursement of Tyco's own selling, general, and administrative expenses. In October 2002,
according to Tyco, it determined that these fees charged to its authorized dealers exceeded its
reimbursable costs and should have been deferred and amortized over the estimated life of the
customer contract -- approximately 10 years.
Tyco restated its financials to give effect to these changes: it reduced reported pre-tax
earnings for fiscal 2002 by $135 million, and took a charge of $185.9 million in fiscal 2002
representing the amount ofrevenue recognized in its fiscal years 1999 to 2001 that should have been
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deferred and amortized over the life ofthe customer contracts . This accounting was also completely
wrong as Tyco and its outside auditor PricewaterhouseCoopers LLP ("PwC"), well knew or
recklessly ignored . When Tyco restated results for its ADT division , it falsely told the investing
public that the Company had another $320.9 million in income that it could recognize over the next
ten years. Tyco knew or recklessly disregarded the fact that these fees charged to dealers could never
be counted as income to Tyco under basic accounting principles.
10. At the time, however, Tyco was motivated by its desire to line up investors to
purchase two large convertible bond issues . In January 2003, Tyco issued $3.4 million of 2.75%
Series A convertible senior debentures due 2018 and $1.5 billion of Series B convertible senior
debentures due 2023. (See Tyco's Form 10-Q for the quarterly period ended March 31, 2003 (the
"March 31, 2003 Form 10-Q"). Tyco received $4.375 billion from the sale of these bonds and used
these proceeds primarily to repay Tyco's enormous debt burden of $3.855 billion . On Dece nber 3 l ,
2002, Tyco also announced that it had entered into a new 364-day revolving credit bank fadility that
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allowed Tyco to borrow up to $1.5 billion. Tyco's stock moved up considerablI on the
announcement in its Form 8-K, from $15.17 to $17.08.
11. After Tyco successfully placed its $4.5 billion bond offering, Tyco annoufnced thati
its accounting problems at its ADT division were far from over. On March 12, 2003, the end of the
Class Period, Tyco announced that it would have to take a $265 to $325 million charge to earnings
for issues identified at its ADT division. Specifically, Tyco announced that it had been inlvolved in
ongoing discussions with the SEC about the "estimated life and method of amortization rtlating to
the dealer account pool." Tyco announced the expected $265-$325 million charge to earnings was
due to a re-restatement of the Company's financial statements to eliminate the bogus accuisition-
related income that had been recognized pursuant to the ten-year income spreading metiodology
announced on December 30, 2002.
12. The Company's stock price dropped on the news from $14.03 on March 12, 2003 to
$12.29 on March 13, 2003, on unusually high trading volume of over 89 million shares.
13. PwC nevertheless gave Tyco a clean audit opinion for Tyco's 2001 and 2002 fiscal
year financial statements which was included in Tyco's September 30, 2002 Form 10-K. Richard
Scalzo ("Scalzo") was the PwC audit engagement partner for PwC's audit ofTyco from Tyco's fiscal
year ended June 30, 1997 to September 30, 2002. Scalzo looked the other way time after time when
it came to certifying Tyco's financial statements. The SEC conducted an investigation in^o PwC's
role in the Tyco financial statement frauds through fiscal 2001. In its Accounting and Auditing
Enforcement Release No. 1839, the SEC concluded that Scalzo knew of the improper accounting
treatment for a whole host of transactions and that the lack of integrity ofTyco's senior management
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in connection with various accounting issues, was apparent. The SEC has barred Scalzo from public
accounting.
II. JURISDICTION AND VENUE
14. The claims asserted herein arise under and pursuant Sections 10(b) and 2c (a) of the
Exchange Act [ 15 U. S.C. §§ 78j(b) and 78t(a)] and Rule I Ob-5 promulgated thereunder by the SEC
[17 C.F.R. § 240. lOb-5].
15. This Court has jurisdiction over the subject matter ofthis action pursuant to 8 U.S.C.
§§1331 and 1337, and Section 27 of the Exchange Act.
16. Venue is proper in this District pursuant to Section 27 of the Exchange Act and 28
U.S.C. §§1391(b) and 1391(d). Tyco is an alien . Tyco's major business unit, Tyco Fire and Services,
which includes ADT, is based in Boca Raton, Florida. ADT is Tyco's single largest businelss. Many
of the acts charged herein, including the dissemination of materially false and misleading
information, occurred in part in the Southern District of Florida and Tyco conducts business in that
District and maintains corporate offices at One Town Center Road, Boca Raton, Florida. This action
was transferred to this District pursuant to the Order of the Multi-District Panel.
17. In connection with the acts alleged in this complaint, Defendants, directly or
indirectly, used the means and instrumentalities of interstate commerce, including, but not limited
to, the mails, interstate telephone communications and the facilities of the national securities
markets.
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III. PARTIES
18, Plaintiffs Ezra Charitable Trust, Mirror Management Limited and Robert) Bovit, as
set forth in their certifications annexed hereto, purchased the common stock of Tyco at 1rtificially
inflated prices during the Class Period and have been damaged thereby.
19. Defendant Tyco describes itself as a conglomerate whose ADT unit is the world
leader in security and fire-protection systems. ADT is the single largest business unit of Tyco,
contributing approximately 30% of total fiscal 2002 revenues from continuing operation. ADT's
principal office is located at One Town Center Road, Boca Raton, Florida. The Company is a
Bermuda corporation with its principal executive office at The Zurich Centre, 90 Pitts lay Road,
Pembroke HMO8 Bermuda. Tyco's common stock is actively traded on the New York Stock
Exchange ("NYSE") under the symbol "TYC." Tyco's fiscal year ends on September 30.
20. Defendant Breen has been Tyco ' s Chairman and Chief Executive Officer Ince July
2002. On August 14, 2002, Tyco filed its Form 10-Q for the quarterly period ended June130, 2002
with the SEC (the "June 30, 2002 Form 10-Q"). According to Breen's employment agreerilent with
Tyco, dated July 25, 2002 and appended as Exhibit 10.1 to the June 30, 2003 Form 10-Q, Breen
would receive the following:
• A "sign-on bonus" of $3.5 million.
• A "sign-on option" to purchase 3,350,000 shares ofthe Company's common
stock at an exercise price of $10; these options would vest and become exercisable in three equal
amounts on July 25, 2003, July 25, 2004 and July 25, 2005.
• 350,000 "sign-on deferred stock units"; these deferred stock units vest in three
equal amounts on July 25, 2003, July 25, 2004 and July 25, 2005.
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• A 2002/2003 "option grant" under the Company's Long Term Ince6tive Plan
to purchase 4 million shares of the Company ' s common Stock at an exercise price of $110; these
Ioptions vest and become exercisable in five equal amounts on the July 25, 2003, July 25, 2004, July
25, 2005, July 25, 2006 and July 25, 2007.
• 1 million 2002/2003 "deferred stock units"; these deferred stock units vest and
become exercisable in five equal amounts on July 25, 2003, July 25, 2004, July 25, 2005, July 25,
2006 and July 25, 2007.
• A base salary of not less than $1.5 million per annum.
• A "Guaranteed 2002 Bonus" based upon a daily pro- rata annual bonaits of $1
million.
• A "Guaranteed 2003 Bonus" of $1.5 million.
• A participation in the Company's bonus and other incentive compensation
plans and programs for the Company's senior executives.
• An annual target bonus measured against objective financial critdria to be
determined by the Board (or a committee thereof) of at least 100% of the $1.5 million Base Salary.
21. Defendant Fitzpatrick became Tyco's Executive Vice President and Chief Financial
Officer on September 18, 2002. Tyco's employment agreement with FitzPatrick, datied as of
September 18, 2002, was filed as an exhibit to Tyco's September 30, 2002 Form 10-K. According
to this agreement, FitzPatrick was entitled to an annual base salary of at least $750,000, a sign-on
bonus of$500,000 and a guaranteed annual bonus for fiscal 2003 of at least 100% ofhis base salary.
Thereafter, FitzPatrick was eligible to earn an annual bonus of at least 100% ofhis base salary, based
upon Tyco's satisfaction of objective financial performance criteria to be determined by the Board.
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Under the agreement, FitzPatrick was also entitled to receive a sign-on option to purchase x,150,000
common shares of Tyco at an exercise price of $16.24 per share and a sign-on grant (Pf 90,000
deferred share units, both of which vested in three equal annual installments over the first three
anniversaries of the agreement, as well as an option to purchase 500,000 common shares of Tyco at
an exercise price of $16.24 per share and a grant of 110,000 deferred share units, both of which
vested in three equal annual installments over the first three anniversaries of the agreement.
FitzPatrick was also entitled to participate in all ofTyco's employee benefit plans available to senior
executives at a level commensurate with his position, and to receive a universal life insurance policy,
supplemental retirement benefits and certain relocation, travel, tax gross-up, financial and tax
planning and other perquisites.
22. Defendant PwC was Tyco's outside auditor. PwC issued an unqualified audit opinion
dated December 23, 2002 on Tyco's Fiscal 2002 and 2001 financial statements that was included
in Tyco's September 30, 2002 Form 10-K. PwC received millions of dollars in consulting and audit
fees from Tyco, as described below.
IV. PLAINTIFFS' CLASS ACTION ALLEGATIONS
23. Plaintiffs bring this action as a class action pursuant to Federal Rule Hof Civil
Procedure 23(a) and (b)(3) on behalf of a Class, consisting of all those who purchased the securities
of Tyco between December 30, 2002 and March 12, 2003, inclusive (the "Class Period") land who
were damaged thereby. Excluded from the Class are Defendants, the officers and/or directors of the
Company, at all relevant times, members oftheir immediate families and their legal representatives,
heirs, successors or assigns and any entity in which Defendants have or had a controlling interest.
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124. The members of the Class are so numerous that joinder of all members is
iimpracticable. As of December 20, 2002, there were approximately 2 billion shares ofl. common
stock of Tyco, according to the Company's September 30, 2002 Form 10-K. Approximately 995
million shares of Tyco common stock were reported traded on the NYSE during the Class Period.
While the exact number of class members is unknown to Plaintiffs at this time and cai only be
ascertained through appropriate discovery, Plaintiffs believe that there are hundreds or thousands
ofmembers in the proposed Class. Record owners and other members ofthe Class maybe identified
from records maintained by Tyco or its agents and may be notified of the pendency of this ction by
mail, using the form of notice similar to that customarily used in securities class actions.
25. Plaintiffs' claims are typical ofthe claims ofthe members ofthe Class as all members
of the Class were, and are, similarly affected by Defendants' wrongful conduct in violation of federal
law.
26. Plaintiffs will fairly and adequately protect the interests ofthe members of khe Class
and has retained counsel competent and experienced in class and securities litigation.
27. Common questions of law and fact exist as to all members of the Class and
predominate over any questions solely affecting individual members of the Class. Among the
questions of law and fact common to the Class are:
a. whether the federal securities laws were violated by Defendants" acts as
alleged herein;
b. whether statements made by Defendants to the investing public during the
Class Period misrepresented material facts about the business and operations of Tyco; and
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c. to what extent the members of the Class have sustained damaged and the
proper measure of damages.
28. A class action is superior to all other available methods for the fair and efficient
adjudication of this controversy since joinder of all members is impracticable. Furthermdre, as the
damages suffered by individual Class members may be relatively small, the expense and burden of
individual litigation make it impossible for members ofthe Class to individually redress the wrongs
done to them. There will be no difficulty in the management of this action as a class action.
V. SUBSTANTIVE ALLEGATIONS
A. Background
29. Tyco's ADT division markets its electronic security services to commercial and
residential customers through both a direct sales force and an authorized dealer network. According
to Tyco's SEC filings, Tyco's ADT division "refocused" its authorized dealer program ' in 2002,
encouraging growth in some geographic areas while curtailing activities in others, "as part of an
enhanced focus on return on investment." (September 30, 2002 Form 10-K).
30. Tyco's ADT division provides, among other things, residential electronic security
systems primarily in North America-, and Europe. Tyco ADT's commercial customers include
financial institutions , industrial and commercial businesses , federal, state and local govelnments,
defense installations, and health care and educational facilities.
31. According to Tyco , its commercial and residential contracts are generally renewed
after their initial terms (September 30, 2002 Form 10-K), and contract discontinuances occur
principally as a result of customer relocation or closure.
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B. The Class Period Begins
i. The Falsity of Tyco' s December 30, 2002 Form 8-K
32. The Class Period begins on December 30, 2002. On that date, Tyco filed a ^orm 8-K
with the SEC (the "December 30, 2002 Form 8-K"), under Breen ' s direction, setting forth the results
and conclusions of a review and investigation of Tyco' s accounting and corporate governaInee. The
December 30, 2002 Form 8-K stated that the review and investigation focused on:
a. the integrity of the Company's financials and the possible existence of
systemic or significant fraud, or other improper accounting that would materially adversely affect
the Company's reported earnings or cash flow from operations in 2003 or thereafter;
b. corporate governance issues at the segment level including an examination
of the post-acquisition integration of acquired companies;
c. revenue recognition procedures and practices;
d. acquisition accounting and reserves;
e. significant corporate level adjusting journal entries;
f, unreconciled inter-company transactions , ifany, between Tyco International
Group, S.A. and other Tyco subsidiaries;
g. recommendations and conclusions concerning the Company's accounting and
corporate governance for the future.
33. Tyco's December 30, 2002 Form 8-K stated that Tyco had conducted a thorough
investigation involving more than 15,000 lawyer hours and about 50,000 accountant hours, and that:
"The Company is not aware of any systemic or significant fraud related to the Company's financial
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statements or of any clear accounting errors that would materially adversely affect the Cpmpany's
reported earnings or cash flow from operations for the year 2003 and thereafter." [emphasis added].
34. The December 30, 2002 Form 8-K led the investment community to belie'e that all
ofthe Company's financial reporting problems had been identified, addressed, and were in the past:
[C]urrent management has concluded that, in the past, the Company in generilsuffered from poor documentation; inadequate policies and procedures to prevent tlemisconduct of senior executives that occurred; inadequate procedures for prop rcorporate authorizations; inadequate approval procedures and documentation; a la kof oversight by senior management at the corporate level; a pattern of usi gaggressive accounting that, even when not erroneous, was undertaken with epurpose and effect of increasing reported results above what they would have be nifmore conservative accounting were used; pressure on, and inducements to, segme tand unit managers to increase current earnings, including by decisions as to whataccounting treatment to employ; and a lack ofa stated and demonstrable commitmentby former senior corporate management to set appropriate standards of ethic's,integrity, accounting, and corporate governance. [emphasis added]
35. The December 30, 2002 Form 8-K described how Tyco's ADT division creaLd bogus
income through transactions in which ADT purchased customer accounts from authorized dealers
and simultaneously charged these dealers for "reimbursement" of ADT's selling, general, and
administrative ("SG&A") expenses in amounts exceeding ADT's true SG&A expenses.
36. According to (1) a former Vice President of Tyco Fire and Security Latin America
which controlled Tyco Mexico!' from 1999 to February 2002 ("Confidential Witness No. 1"), (2)
' According to an internal Tyco report dated August 9, 2001 to Gustavo Islas Me{az(General Manager) from Rafael Garcia (Internal Audit Manager) and Ian Nilson ( Senior ]eternalAuditor) regarding "Tyco First and Security -- ADT Mexico," Tyco established ADT Melcico inMay 1999. As of August 2001, according to the August 9, 2001 internal Tyco report, APT had96 different authorized dealers in Mexico alone who were responsible for installing securitysystems and selling ADT monitoring and maintenance services . Tyco wrongfully cancelled thisauthorized dealer program in August 2002 and was sued by its Latin American authorized dealersin Mexico . Tyco has never disclosed the existence of this lawsuit or the enormous contingentliability that an adverse judgment in that suit represents . In addition , according to Confid',entialWitness No. 3, ADT charged back millions of dollars to authorized Latin American dealers when
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another former Vice President and Acting President of ADT Mexico who left this position in
October 2001 ("Confidential Witness No. 2"), and (3) an owner of one of the authorized ADT
dealers based in Mexico whose contracts with ADT were cancelled by ADT in Au^ust 2002
("Confidential Witness No. 3"), the ADT transactions worked as follows:
a. ADT agreed to pay $1,000.00 to an authorized dealer to acquire a (customer
contract.
b. At the same time, the authorized dealer agreed to pay ADT $200.00 as
"reimbursement" of SG&A expenses.
c. ADT would remit $800.00 (the net amount) to the authorized dealer and
record (i) the acquisition of a $1,000 . 00 intangible asset (customer contracts related ustomer
relationships) which was later amortized over a number of years; and (ii) a $200.00 expense offset
(income).
d. According to Confidential Witnesses Nos. I & 2, Tyco's true SG&A Qxpenses
associated with the acquisition were de minimus and amounted to only about $5.00 for a credit check
of the prospective customer -- far less than the $200 Tyco was recording. ADT thusIrecorded
income to the extent to which the "reimbursement" exceeded its true cost on each contract
purchased.
it cancelled their contracts in August 2002, claiming that these dealers' customers had capcelledtheir contracts prior to the expiration of 12 months. According to Confidential Witness No. 3, apreliminary review of documents related to the Mexican litigation between the authorized dealersand ADT, shows that many of the customers that ADT claimed had cancelled their contracts arein fact still customers of ADT. The full extent of the number of improper charge-backs that ADTis responsible for is still subject to investigation and discovery.
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e. In substance, ADT acquired the customer contract for $805.00 ($800.00 paid
to the dealer and $5.00 paid in acquisition-related SG&A expenses), recorded the acquisition of an
asset with an assigned book value of $1,000.00, and recognized income of $195 (presumably under
the theory that the company acquired something worth $1,000.00 for $805.00). This rhethod of
accounting is contrary to GAAP (ARB No . 43, Ch. 5, Par. 4) which states: "The initiJI amount
assigned to all types of intangibles should be cost , in accordance with the generally accepted
accounting principle that assets should be stated at cost when they are acquired."2/
37. According to Confidential Witnesses No. 1 and No. 2, when ADT's authorized dealer
program began, Richard D. Power ("Power"), ADT's Vice President of Finance based in Boca
Raton, Florida , came up with the idea of the $200 connection fee for the authorized d^alers, as
discussed above. According to these witnesses , this plan was simply designed as a profit center, and
ADT's world-wide offices were instructed to pay dealers a $ 1,000 commission and then in''oice and
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instruct the dealers to pay ADT a $200 connection fee. The $200 was carried as aprofit. According
to Confidential Witnesses Nos. I & 2, Power decided not to charge more than $200 because it
would raise redflags.
38. Tyco's December 30, 2002 Form 8-K discussed the Company' s restatement of
previously issued financial statements , which purported to correct the Company's prior improper
accounting for these bogus income-generating asset acquisition transactions:
The concept of recording assets at cost is basic GAAP accounting . To accept, asGAAP, an accounting method which permits an asset to be recorded at an amount in excess of itsacquisition cost and income to be recorded to the extent that the (inflated) recorded asset amountexceeds its true cost, is knowing or reckless error . Tyco 's "Alice In Wonderland" accounting isanalogous to paying $ 35,000 for a car with a sticker price of $40,000, and then recording:the costof the car as $40 ,000 and income of $5,000.
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Although not revenue recognition per se, there were analogous issues at Aincluding with regard to fees charged to dealers when service contracts vpurchased. These fees were charged to dealers at the time of a customer acctpurchase and were recorded as a reimbursement of selling, general,administrative expenses. In October 2002, the Company determined that the ;recorded as a reimbursement of costs were in excess of reimbursable costs incurand should be deferred and amortized over the estimated useful life of an acquicustomer relationship. Thefirst three quarters of2002 were restated to give ofto such changes. The result of the Company's decision was to reduce repotpre-tax earnings during fiscal year 2002 by $135 million. In addition,Company is taking a charge of$185.9 million in fiscalyear 2002 representingamount of revenue effectively recognized in the fiscal years 1999 to 2001 tshould have been deferred and amortized over the estimated useful life ofaccount. [emphasis added]
39. The above-described restatement, however, did not eliminate the recording ofbogus
contract acquisition-related income as GAAP required. The restatement caused Tyco to remove a
portion of the bogus income from previously issued financial statements and to re-recognize the
income over ten years (spreading the income over the purported life of the contracts acquired). But,
the effect of this was that Tyco falsely advised the investment community that it now hadia $320.9
million pipeline ofpreviously "improperly" recognized income that could be recognized a's income
over the next several years. As discussed below, Tyco had no such "backlog" of revenue and this
representation was materially false and misleading.
ii. The Falsity of Tyco 's Form 10-K
40. Tyco's September 30, 2002 Form 10-K was signed and certified under the larbanes-
Oxley Act as true and accurate by defendants Breen and FitzPatrick. It stated:
Our controls are improving and new senior management has no reason to believethat the financial statements included in this report are not fairly stated in allmaterial respects. [emphasis added]
i41. The September 30, 2002 Form 10-K discussed the Company's accounting for ADT
contract acquisition-related income as follows:
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Contracts and related customer relationships result from the Company purchasingresidential monitoring contracts from an external network of independent dealerswho operate underADT's authorized dealer program. The purchase price ofcustomercontracts is recorded as an intangible asset and amortized to selling, general andadministrative expense on a straight-line basis over the period of the economicbenefits expected to be obtained from the customer relationships, which is presentlyestimated to be ten years. The resulting amortization approximates the patternwhich the Company estimates it will obtain those benefits and considers customerattrition. The Company incurs costs associated with maintaining and operating itsdealer program, including brand advertising, and for due diligence performed by theCompany with respect to contracts offered by the dealers for purchase. Dealersreimburse the Company a non-refundable amount for each ofthe contracts purchasedrepresenting their reimbursement of those costs described above . The Companyrecognizes this non-refundable charge at the time the contract is accepted forrpurchase. The costs incurred by the Company and the related reimbursements arjeincluded in selling, general and administrative expenses within the ConsolidateStatements of Operations. To the extent that the amount of dealer reimbursement dfthe Company' s administrative and connection costs exceed the actual costs incurre ,the excess is recorded as a deferred credit and amortized on a straight line-basis ovdrthe estimated period of the economic benefits, which is estimated to be ten year.Prior to fiscal 2002, the Company recognized in earnings the entire amount Ofreimbursements from dealers. During the first six to twelve months after purchase fthe customer contract, any cancellation of monitoring service, including those th tresult from customer payment delinquencies, results in a chargeback by the Companyto the dealer of the full amount of the contract purchase price. The Company recordlsthe chargeback amount from the dealer as a reduction of the previously recordedintangible asset.
The Company determined the amounts reimbursed from dealers under ADT'sauthorized dealer program exceeded the costs actually incurred. The cumulativeeffect of reimbursements recorded in years prior to fiscal 2002 in excess of costsincurred, net of the effect of the deferred credit, which would have been amortizedas described further in Note 1, is $185.9 million [$33.6 million, $53.5 million an6$98.8 million related to periods prior to fiscal 2000, fiscal 2000 andfiscal 20011,respectively].
[W]e continue to be engaged in a dialogue with the SEC's Division of CorporatioriFinance, as part ofa routine review ofourperiodicflings. While we believe thatwe have resolved the material accounting issues prior to filings there can be noassurance that the resolution of the remaining comments issued by the Staff will not
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necessitate one or more amendments to this or prior periodic reports. [emphas sadded].
42. The market reacted favorably to the news that all material accounting issues had been
resolved, that Tyco's prior improper accounting had been corrected, and that a $320.9 million
pipeline of ADT contract acquisition-related income existed and would be recognized, for
accounting purposes, over the next several years. Tyco's stock price jumped from a cloJ.ing price
of $15.17 on the trading day before Tyco's September 30, 2002 Form 8-K and September 30, 2002
Form 10-K were filed with the SEC (December 27, 2002), to a closing price of $17.08 on the day
following these filings (December 31, 2002). During the weeks that followed, Tyco's stock price
continued to climb, closing at $18.20 on January 16, 2003. Tyco never identified the nature of the
"administrative and connection" costs it referred to in its September 30, 2002 Form 10-I.
43. On December 31, 2002, Tyco announced that it had entered into a new; 364-day
revolving credit bank facility that allowed Tyco to borrow up to $1.5 billion. In January 20103, Tyco
issued $3.4 million of 2.75% Series A convertible senior debentures due 2018 and $1.5 Iillion of
Series B convertible senior debentures due 2023. (See March 31, 2003 Form 10-Q). Tyco^received
$4.375 billion from the sale of these bonds and used these proceeds primarily to repay Tyco's
enormous debt burden of $3.855 billion.
44. Tyco's disclosures in its September 30, 2002 Form 8-K and September 30,20i02 Form
10-K falsely stated or falsely implied that: (1) Tyco's accounting had been corrected; (2) the financial
istatements and other financial information included in the September 30, 2002 Form 10-K fairly
presented Tyco 's financial condition and results of operations ; (3) the material accounting issues
(including the Company' s accounting for ADT contract acquisition-related income) had been
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resolved; and (4) a $320.9 million pipeline or back log ofADT contract acquisition-related revenue
existed and would be recognized over the next several years.
45. As discussed below in ¶¶47-49, Tyco later admitted that the accounting fdr income
from its dealer contracts was false and misleading, requiring Tyco to again restate its financial
results.
VI. THE TRUTH IS REVEALED
46. On March 12, 2003, the end of the Class Period, Tyco issued a pres 's release
disclosing that in its March 31, 2003 financial statements, the Company expected "to take ton-cash,
pre-tax charges that are estimated to be between $265 million and $325 million for issues identified
primarily in its Fire & Security Services business [ADT]. These charges are expected to lower
earnings by $0.09 to $0.11 per share." Defendants also announced that ADT Presiddnt, Jerry
Boggess, had been terminated, along with other senior management. Breen was quoted in the press
release as stating that the terminations of senior management were needed "to strengthefi ADT's
operating margins, improve performance and make [ADT] a more efficient and well-run enterprise."
In response to the announcement , Tyco's common stock fell from a close of $14.03 per share on
March 12, 2003 to $12.29 per share on March 13, 2003, on unusually high trading volume of
89,684, 200 shares . (Average daily trading volume for Tyco stock during the Class Period was
approximately 20 million shares).
47. Further disclosure on the announced $265-$325 million charge to earnings appeared
in the March 31, 2003 Form 10-Q, which disclosed that:
a. contrary to representations which appeared in the December 30, 2002 Form
8-K and the September 30, 2002 Form 10-K, the Company had been involved in "ongoing
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discussions with the SEC" regarding "the estimated life and method of amortization relat#ng to the
dealer account pool, as well as the Company's accounting for the non-refundable charge rFlating to
the dealer program."
b. the announced $265-$325 million charge to earnings which was announce
March 12, 2003 was due to re-restatement of the Company's financial statements to eliminate the
bogus acquisition-related income that had been recognized pursuant to the ten year bogus income
spreading methodology announced December 30, 2002. (The re -restatement was a I de facto
iadmission that the previously issued financial statements -- including the audited fiscal 2001 and
2002 financial statements that PwC opined upon in Tyco's September 30, 2002 Form 10-K -- were
materially false and misleading).
48. The March 31, 2003 Form 10-Q discussed the re-restatement of the Company's
financial statements to address the Company's improper and non-GAAP accounting for the bogus
contract acquisition-related income:
As discussed in the Company's Annual Report on Form 10-K for the fiscal yearended September 30, 2002, the Company incurs costs associated with maintaininlgand operating its ADT authorized dealer program. Dealers reimburse the Companya non-refundable amount for each of the contracts purchased representing theirreimbursement of such costs. The Company recognizes this non-refundable charglat the time the contract is accepted for purchase. Prior to fiscal 2002, the Companyrecognized in earnings the entire amount of reimbursements from dealer4.Commencing October 1, 2001, to the extent that the amount of dealer reimbursementexceeded the actual costs incurred by the Company, the excess was recorded as adeferred credit and amortized on a straight line-basis over ten years. As described inthe following paragraph, during the quarter ended March 31, 2003, the Company haschanged its method ofaccounting for these reimbursements from dealers, retroactiveto October 1, 2002.
FASB's Emerging Issues Task Force ("EITF") recently issued EITF 02-16,"Accounting by a Customer (Including a Reseller) for Certain ConsiderationReceived from a Vendor," which is applicable to the arrangement between the
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Company and its authorized dealers for the electronic security services business. T1}eissues addressed in EITF 02-16 were brought to the EITF for the purpose faddressing the wide diversity found in practice, across a variety of arrangements a dindustries, in accounting for payments received by purchasers of goods and servicesfrom vendors or suppliers. Pursuant to this consensus, the consideration received IllyADT relating to the non-refundable charge to each dealer for reimbursement ofADffcosts to support the dealer program should be presumed to be a reduction in the costto ADT of acquiring customer contracts.
Based on the transition rules of EITF 02-16, we are required to apply this nconsensus to all customer contracts acquired after December 31, 2002. As permitunder EITF 02-16, during the second quarter of fiscal 2003, the Company chantits method of accounting for the consideration received by ADT for 1non-refundable charge to dealers for reimbursement of ADT costs to supportdealer program retroactive to the beginning of the fiscal year. This was reporteda $206.7 million after-tax ($265.5 million pre-tax) charge for the cumulative effofchange in accounting principle in the Consolidated Statement ofOperations for isix months ended March 31, 2003, retroactive to October 1, 2002. The impact on Ibalance sheet of the cumulative adjustment is a decrease in net intangible assets$566.8 million and a decrease in liabilities for the previously deferred non-refundalcharge to dealers of $301.4 million.
In addition to the charge for the cumulative effect of the change in accountin,described above, the impact of adopting this accounting change was to decrease thepurchase price of customer accounts acquired from the dealers by $32.0 million anl$74.0 million for the quarter and six months ended March 31, 2003, respectively. Thelimpact of the change on results of operations for the quarter ended March 31, 200was an increase to both loss from continuing operations and net loss of $5.7 millio($7.0 million pre-tax). The change had no effect on loss from continuing operationsper common share or net loss per common share for the quarter ended March 3 1,2003. The impact of the change for the six months ended March 31, 2003, before thecharge for the cumulative effect of the change discussed above, was a decrease tpboth income from continuing operations and net income of $14.7 million ($18.5million pre-tax) or $0.01 per common share.
49. Although the Company' s accounting for the bogus income had ultimately been
corrected, the March 31, 2003 Form 10-Q falsely attributed the correction to compliance with EITF
02-16. EITF 02-16, however, required various other business acquisition arrangements to conform
to the accounting specified in GAAP (ARB No. 43, Ch. 5, Par. 4) as discussed above -- the
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accounting which Tyco was always required to apply in conjunction with the aequisit^on of its
intangible assets." EITF 02-16 addresses accounting by a customer (including a reseller)4
r certain
consideration received from a vendor (a vendor is defined in EITF 02-16 as "a service provider or
product seller, such as a manufacturer, distributor, or reseller"), such as rebates and coupons. Tyco
was not buying products or services from a manufacturer, distributor, or reseller and receiving
rebates and coupons. It was buying intangible assets, i, e., contracts from its authorized dealers. The
accounting literature addressing such intangible assets is ARB 43, which had addressed ibe issue
since its issuance in 1953. EITF 02-16 came about to address "how a reseller ofa vendor's products
should account for cash consideration (as that term is defined in Issue 01-9) received from a vendor"
( someone reselling a product or service).
50. In addition, the financial statements contained in Tyco's March 31, 2003 Fdrm 10-Q
set forth over $900 million of additional charges to earnings to correct a host of other accounting
improprieties. As disclosed in the March 31, 2003 Form 10-Q:
During the quarter ended March 31, 2003, the Company intensified a procesbwhereby internal audits and detailed controls and operating reviews were conducted.As a result ofthis process, the Company recorded $471.4 million ofpre--tax chargesrelating to new information and changes in facts and circumstances occurring duringthe quarter. The process included assessing the continued recoverability of asset ,including accounts receivable, inventory and installed security systems and equit1investments, and the estimates of costs relating to legal, environmental and insuranceobligations. The assessments were based primarily on an analysis of recent eventsand more detailed experience that occurred during the quarter. Concurrent with thiLreview process and resulting assessments by management during the quarter,decisions were made to discontinue existing product lines and terminate informationtechnology systems implementation projects. As a result ofthese decisions, inventoryand other asset balances were written down to their net realizable value.
3 ARB No. 43 was issued in June 1953.
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The charges of $471.4 million include $165. 0 million related to increased ci
oI testimatesfor environmental, legal andproduct liability, workers compensation a dgeneral liability insurance accruals, $107.8 million related to accounts receivab eand inventory reserve valuations, $84.1 million related to an other than tempora*ydecline in the value of investments, $36.6 million for account write-offs, whelemanagement concluded that the recoverability ofvarious asset balances which hardbecome doubtful, and $77.9 million for other accounting estimate changes. TheCompany also recorded an expense of $91.5 million for a retroactive, increment Ipremium on prior period directors and officers insurance coverage negotiated withits third party insurance carriers during the quarter (see Note 12).
As a result ofthe Company's intensified internal audits and detailed controls ioperating reviews, the Company identified and recordedpre-tax charges of$43million for charges related to prior periods. These charges resulted frcapitalizing certain selling expenses to property, plant and equipment and ofnon-current assets, mostly in the Fire and Security Services segmentreconciliation items relating to balance sheet accounts where certain account anal'or periodic reconciliations were deficient, resulting in adjustments primarily relato the Engineered Products and Services segment. Additionally, charges related tocorrection of balances primarily related to corporate pension and defercompensation accruals as of September 30, 2002 and other accounting adjustmc(e.g. purchase price accounting accruals, deferred commissions, accounting relato leases in the Fire and Security Services and Engineered Products and Servisegments)...
51. The additional $905.9 million in charges to earnings -- a large part of which resulted
from the identification of new information" and $434.5 million of which applied to accounting
periods prior to the quarter ended March 31, 2003 (including the fiscal 2001 financial stlitements
which PwC audited and opined upon) -- is additional evidence that Tyco's December 30, 2002
statement that its accounting had been corrected and material accounting issues resolied, was
materially false and misleading.
VII. AUDITOR LIABILITY
52. The following allegations relate to PwC's liability for its issuance of an unqualified
audit opinion on Tyco's financial statements for Tyco's fiscal years ended September 30, 2001 and
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September 30, 2002. PwC's audit opinion was dated December 23, 2002 and appeared In Tyco's
September 30, 2002 Form 10-K.
53. PwC provided auditing and other services to Tyco, and received substantial payments
for its work.
54. Scalzo was the PwC "engagement partner for the firm's audits of the financial
statements ofTyco, beginning with the Tyco fiscal year ended June 30, 1997, and continuing through
Tyco's fiscal year ended September 30, 2002." (Accounting And Auditing Enforcement Rekease No.
1839; August 13, 2003).
55. On December 23, 2002, PwC issued a report containing an unqualified audit opinion
on Tyco's consolidated financial statements for the fiscal years ended September 30, 2001 and 2002.
This report, which Tyco included in its September 30, 2002 Form 10-K with PwC' s consent, stated:
In our opinion, the accompanying consolidated balance sheets and the relatIidconsolidated statements of operations, of shareholders' equity and of cash flowspresent fairly, in all material respects, the financial position ofTyco International W.and its subsidiaries at September 30, 2002 and 2001, and the results of theiroperations and their cash flows for each of the three years in the period endedSeptember 30, 2002, in conformity with accounting principles generally accepted iithe United States ofAmerica. In addition, in our opinion, the accompanying financi.lstatement schedule presents fairly, in all material respects, the information set forththerein when read in conjunction with the related consolidated financial statement.These financial statements and financial statement schedule are the responsibility ofthe Company's management; our responsibility is to express an opinion on thesefinancial statements and financial statement schedule based on our audits. Weconducted our audits of these statements in accordance with auditing standardsgenerally accepted in the United States of America, which require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements,assessing the accounting principles used and significant estimates made bI
Ymanagement, and evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion. [emphasis added]
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56. PwC's December 23, 2002 unqualified auditor ' s opinion on the Company' s fnancial
statements was materially false and misleading because these financial statements were not resented
in accordance with GAAP, nor were they audited in accordance with GAAS. GAAS (AU Section
411) describes: "The Meaning ofPresent Fairly in Conformity With Generally Accepted Accounting
Principles in the Auditor's Report." It states:
The auditor's opinion that financial statements present fairly an entity's finan(position, results of operations, and cash flows in conformity with generally accepaccounting principles should be based on his judgement as to whether (a)accounting principles selected and applied have general acceptance; (b)accounting principles are appropriate in the circumstances; (c) the financstatements, including the related notes, are informative of matters that may afitheir use, understanding, and interpretation...; (d) the information presented infinancial statements is classified and summarized in a reasonable manner, thatneither too detailed nor too condensed...; and (e) the financial statements reflectunderlying events and transactions in a manner that presents the financial positiresults of operations, and cash flows stated within a range of acceptable limits, tis, limits that are reasonable and practicable to attain in financial statements.
57. As particularized above, the financial statements which were contained within the
Company's financial statements and which were distributed to the investing public were not
presented "fairly... in conformity with generally accepted accounting principles" because the:
Accounting principles selected and applied in the preparatio>a of the
Company's financial statements did not have general acceptance.
b. Accounting principles which pervasively impacted the Company's kinancial
statements were not appropriate in the circumstances.
Company's financial statements , including the related notes, were not
informative of matters that affected their use, understanding, and interpretation.
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d. Company's financial statements did not reflect the underlying events and
itransactions in a manner that presented the financial position and the results of operation within a
range of acceptable limits that were reasonable and practicable to attain in financial statements.
58. PwC knew it was required to adhere to standards and principles of GAAS, iincluding
the requirement that its report state whether or not the financial statements complied in all' material
respects with GAAP.
59. PwC, in issuing its unquali fied opinion , as alleged herein , knew that by doing so it
was engaging in a gross departure from GAAS , or issued such opinion with reckless disregard for
whether or not GAAS was being complied with.
60. In the introductory portion ofSEC Accounting Series Release No.173, the SEC made
the following comments pertaining to economic substance:
Another problem ... is the need for emphasizing the importance of substance ov^rform in determining accounting principles to be applied to particular transactions andsituations. In addition to considering substance over form in particular transaction,it is important that the overall impression created by the financial statements brconsistent with the business realities of the company's financial position andoperations.
We believe that the auditor must stand back from his resolution of particularaccounting issues and assess the aggregate impact of the particular issues upon areasonable investor's perception of the economic substance of the enterprise fairwhich the financial statements are being presented.
61. As alleged above, Tyco materially overstated its reported earnings through a non-
GAAP recordation of bogus contract acquisition -related income and through numerous other
material transactions wherein there was a failure to account for their substance.
62. In opining on the fairness of the Company's financial statements , PwC specifically
represented that its audit included " assessing the accounting principles used...by management," as
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well as "evaluating the overall financial statement presentation." This representation was materially
false and misleading because PwC either failed to assess the propriety of the accounting principles
Tyco used, and failed to consider the Company's use of aggressive and non-GAAP accounting and
the importance of substance over form in determining accounting principles to be appliedlor did so
in an egregiously reckless manner. This fact is apparent from the re-restatement of Tyco's financial
statements to eliminate the bogus acquisition-related income that had been recognized pursuant to
ithe ten-year bogus income spreading methodology announced December 30, 2002 and blessed by
PwC through certification of Tyco's fiscal 2002 financial statements.
63. PwC's unqualified opinions, insofar as they stated that PwC's audits of the
Company's financial statements were conducted in accordance with GAAS, were false and
misleading because the following GAAS (AU 150) were knowingly or recklessly violated:
a. General Standard No. I was violated, which standard requires that 'the audit
is to be performed by a person or persons having adequate technical training and proficiency as an
auditor.
b. General Standard No. 3 was violated, which standard requires that due
professional care is to be exercised in the performance of the audit and in the preparation of the
report.
Standard Of Field Work No. 1 was violated, which standard requires that the
work is to be adequately planned and assistants, if any, are to be properly supervised.
d. Standard Of Field Work No. 2 was violated, which standard requires that a
sufficient understanding of internal control is to be obtained to plan the audit and to determine the
nature, timing, and extent of tests to be performed.
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C. Standard Of Field Work No. 3 was violated, which standard req^ires that
sufficient competent evidential matter is to be obtained through inspection, observation, inquiries,
and confirmations to afford a reasonable basis for an opinion regarding the financial statements
under examination.
f. Standard Of Reporting No. 1 was violated, which standard requires that the
report shall state whether the financial statements are presented in accordance with enerally
accepted accounting principles.
g. Standard Of Reporting No. 3 was violated, which standard requires that
informative disclosures in the financial statements are to be regarded as reasonably adequalte unless
otherwise stated in the report.
64. The Company was required to disclose in its financial statements the existence of the
material facts described above and to appropriately report transactions in conformity with GAAP.
The Company failed to make such disclosures and to account for and to report transactions in the
Company's financial statements in conformity with GAAP. PwC was, therefore, required Pursuant
to GAAS, to express a qualified opinion on the Company's financial statements (AU Sec$ion 508)
and, in so doing, to disclose to the investing public the nature and extent of the Comparry's non-
GAAP accounting and to provide those disclosures which the Company's financial statemefits failed
to provide.
65. On December 23, 2002, PwC violated GAAS in failing to provide those disclosures
which the Company's financial statements failed to provide and in failing to express a qualified
opinion on Tyco's financial statements for the fiscal years ended September 30, 2001 and 2002.
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r
66. PwC knew and ignored or recklessly failed to know the facts which indicated that the
Company's financial statements for the fiscal years ended September 30, 2001 and 211102 were
materially false and misleading for the reasons set forth above, and were presented in a manner
which violated the principles of fair financial reporting and GAAP.
67. As particularized above, PwC failed to comply with GAAS in that it failed to perform
its audits of the Company's financial statements with a proper degree of professional slQepticism
(GAAS - AU Section 316). PwC identified and ignored certain evidence that the Company's
financial statements were materially misstated via fraudulent accounting.
68. PwC identified and ignored and failed to investigate extremely questionable
transactions, and made audit judgments that no reasonable auditor would have made if cdnfronted
with the same facts. Accordingly, PwC audits were so deficient that they amounted to nv audit at
all. In this regard, it is incomprehensible that, during its fiscal 2002 audit, PwC focused substantial
audit effort on the issue of ADT's non-GAAP recordation of bogus contract acquisition-related
income and permitted the Company to change to a second non-GAAP method of accounting
permitting the recognition of this bogus income over time.
69. Had PwC performed its audit pursuant to GAAS, it would have known that the
Company's financial statements for the fiscal years ended September 30, 2001 and 2602 were
materially false and misleading because these financial statements were not presented in accordance
with GAAP. In reckless disregard of professional standards, PwC failed to audit the Company's
financial statements for the fiscal years ended September 30, 2001 and 2002 in conformity with
GAAS.
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70. The falsity of the reported financial results which PwC had certified was
acknowledged a few months later when the Company announced a re-restatement of the fi$ca12001
and fiscal 2002 financial statements which PwC certified as compliant with GAAP on Decdmber 23,
2002.
71. On July 29, 2003, Tyco issued a press release announcing that "following discussions
with the Securities and Exchange Commission, it has restated its historical financial statements."
The press release stated that "the effects of the restatement of these charges are to reluce the
Company's previously reported results for fiscal years 1998-2001 and to improve the previously
reported results for fiscal 2002 and the first six months of fiscal 2003." It also stated thai:
a. The restatement included two previously recorded charges related to Ithe ADT
business reflecting a change in the amortization method for customer contracts acquired through the
ADT dealer program ($364.5 million pre-tax) and a change in accounting for the AI7:T dealer
program connect fee ($265.5 million pre-tax).
b. The Company was restating pre-tax charges of$434.5 million for item s related
to prior periods and pre-tax charges of $261.6 million recorded in the quarter ended December 31,
2001
c. The Company was restating prior periods for $71. 5 million in pre-tax charges
primarily related to workers' compensation and general liability accruals.
d. The Company was restating prior periods for $46.6 million of cumulative
pre-tax charges related to split dollar life insurance arrangements for former senior executives.
72. On August 13, 2003, the SEC issued Accounting And Auditing Enforcement Release
No. 1839 based upon its investigation ofPwC's role in the Tyco financial statement frauds through
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c
fiscal 2001. As discussed more fully below, the SEC Release stated that Scalzo knew of the
improper accounting treatment for, and non-disclosure of, executive bonuses and feed paid in
connection with the TyCom IPO, the ADT Automotive Divestiture , the FLAG Telecom Transaction,
and the CIT transaction. The Release also stated that the lack of integrity of Tycol s senior
management in connection with deceptive practices and false statements was apparent in connection
with Tyco's:
a, representations regarding the purported nature and extent of KELP' loans.
b. refusal to disclose non-interest-bearing "relocation" loans.
c. use of post-period adjustments to off-set unanticipated fiscal year 1998
compensation charges.
d. use of post-period adjustments to off-set unanticipated fiscal yEar 1999
purchase accounting charges.
e. continued use of general unallocated reserves even though Tycol s senior
management had been repeatedly advised that such reserves were prohibited by GAAP.
73. SEC Accounting And Auditing Enforcement Release No. 1839 further states that,
"having been put on notice, Scalzofailed to take steps required by GAAS" and that, accdrdingly,
Scalzo "was responsiblefor audit reportsfalsely stating that PwC had conducted the Tydo audits
in accordance with GAAS."
A. Additional Scienter Allegations Relating to Tyco, Breen and Fitzpatrick
74. Defendants Tyco, Breen and Fitzpatrick had the opportunity to make the alleged false
and misleading statements and possessed the motive to do so: to enable defendants to convince the
market that the actions taken by Tyco were all that were necessary to clean up the financial
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statements of Tyco and to put the proper senior management in place. This enabled Ty^o to (1)
continue reporting quarterly earnings growth and achieve the full fiscal year 2003 cash flow and
earnings guidance they had provided the market ; (2) sell to the unsuspecting market more han $4.5
billion of convertible bonds which could not have been sold in the volume and at the prices and
interest rates offered but for Defendant ' s misrepresentations concerning the purported strength of
Tyco's business and financial condition, for fiscal year 2003 and beyond, and the favorable impact
of those misrepresentations on Tyco's common stock price; and (3) secure necessary funding in the
form of a revolving bank credit facility which Breen admitted was necessary to eliminate the
liquidity gap Tyco otherwise would have faced in fiscal 2003.
75. Breen and Fitzpatrick had generous compensation packages as set forth kbove in
¶¶20-21, which provided a strong motive to artificially inflate Tyco's stock price.
76. With a personal fortune tied to his 7.35 million options and the 1.35 millionideferred
stock units, Breen had no interest in expeditiously and decisively addressing the fraudulent
accounting which materially impacted Tyco's financial statements. Such an action would have
severely depressed the price of the Company's stock, thereby causing Breen to sustain huge ersonal
losses, and it would have resulted in downgrades of Tyco's debt by credit rating organizations,
posing a serious threat to the very existence of Tyco. As stated in the Company's September 30,
2002 Form 10-K:
We learned ofinstances ofbreakdowns ofcertain internal controls during fiscal 2002.
This began in January 2002 when our Board ofDirectors learned of an unauthorized
payment to our former Lead Director, Frank E. Walsh, and eventually led to the
Board replacing our senior management team. These instances included abuse ofour
employee relocation loan programs, unapproved bonuses, attempted unauthorized
credits to employee loans, undisclosed compensation arrangements, unreportedperquisites, self-dealing transactions and other misuses of corporate trust, and have
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been widely reported in the press. We believe the publicity resulting frominstances negatively impacted our results of operations and cash flow in fiscal:In addition, suchpublicity contributed to a deterioration in ourfinancial coneas we lost access to the commercial paper market and credit ratings on ourdebt declined duringfiscal 2002from ratings as ofthe end offiscal 2001.
As a result ofthis negative publicity, the prices of our publicly traded securities hadeclined significantly and we have experienced reluctance on the part of certacustomers and suppliers to continue working with us on customary terms.number of suppliers have requested letters of credit to support our purchaorders.
77. A September 11, 2002 press release announced the September 10, 2002
of FitzPatrick as Tyco's Executive Vice President and Chief Financial Officer. According to the
press release, FitzPatrick was well versed in GAAP: he held "a bachelor's degree in accounting from
the University ofIllinois, where he graduated with high honors." The press release quoted
Breen as stating:
One ofmy highest priorities is building an exceptionally capable management teathat will bring top talent and experience to the challenges and opportunities we faat Tyco. Dave FitzPatrick is a world-class executive with exceptional credibilitythe financial community and I am extremely pleased that he is joining the new teaat Tyco. His experience and accomplishments at United Technologies and earlierKodak and General Motors are right on target for the needs here. Dave's respect alreputation among the financial community for uncompromising integrity, and 1overall grasp of financial and business issues, are strengths that I value highly. Hea perfect fit for Tyco.
78. Therefore, Breen and FitzPatrick contrived and executed a plan wh4eby the
Company's prior accounting frauds would be disclosed and rectified slowly over time in order to dull
the impact of its revelation on the price of the Company's stock.
79. Breen and FitzPatrick knew by no later than early September 2002, based on Tyco's
civil complaint filed in the United States District Court for the Southern District of NewiYork on
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September 12, 2002 against its former Chairman and ChiefExecutive Officer, L. Dennis K zlowski,
that a Company commissioned review ofcertain accounting issues had revealed that Kozl wski had
surreptitiously and fraudulently (through an "unauthorized forgiveness and gross-up f Florida
relocation loan liability" which the recipient had agreed to hold secret), granted a:
a. $5,000,000 tax free gift to Jerry Boggess (President ofTyco Fire and Security
Services [ADT] and one of Kozlowski's "key managers") for no valid business reason.
b. $3,109,971 tax free gift to Irving Gutin (Senior Vice President anc1 General
Counsel and one of Kozlowski's "key managers") for no valid business reason. Similarl', current
management knew that "only a few weeks after the unauthorized forgiveness and gross-up ^fFlorida
relocation loan liability" Kozlowski had granted Irving Gutin a $500,000 cash bon' s and a
$2,637,804 "relocation" benefits for a total second-wave-gratuity of $3,137,804; that Gu in had to
have known that the payment of the second "relocation" benefit was duplicative and did riot return
immediately it to the Company.
c. $825,000 tax free gift to Jeffrey Mattfolk (Senior Vice President of Tyco
International Inc. and Director Mergers & Acquisitions and one ofKozlowski's "key manakers") for
no valid business reason. Similarly, current management knew that "only a few weeksiafter the
unauthorized forgiveness and gross-up of Florida relocation loan liability" Kozlowski hat granted
Jeffrey Mattfolk a $312,500 cash bonus, restricted shares of stock valued at $424,590, and a
$699,746 "relocation" benefit for a total second-wave-gratuity of $1,436,836; that Mattfoilk had to
have known that the payment of the second "relocation" benefit was duplicative and did not
immediately return it to the Company.
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d. $1,942,026 tax free gift to Brad McGee (Senior Vice President) of Tyco
International Inc. - Media Relations and one of Kozlowski's "key managers ") for no valid) business
reason . Similarly, current management knew that "only a few weeks after the
forgiveness and gross-up of Florida relocation loan liability" Kozlowski had granted Brad McGee
a $500,000 cash bonus, restricted shares of stock valued at $424,590, and a $1,647,181 `
benefit for a total second-wave -gratuity of $2,572,771; that McGee had to have known that the
payment of the second "relocation" benefit was duplicative and did not immediately returi it to the
Company.
C. $748,309 tax free gift to Patricia Prue (Senior Vice President of Human
Resources and one ofKozlowski's "key managers") for no valid business reason. Similarli, current
management knew that "only a few weeks after the unauthorized forgiveness and gross-up
relocation loan liability" Kozlowski had granted Patricia Prue a $312,500 cash bonus and ^estricted
shares of stock valued at $424,590 for a total second-wave-gratuity of $737,090.
f $1,063,355 tax free gift to Michael Robinson (Senior Vice Presilent and
Treasurer and one of Kozlowski's "key managers") for no valid business reason. Similarly, current
management knew that "only a few weeks after the unauthorized forgiveness and gross-up
relocation loan liability" Kozlowski had granted Michael Robinson a $312,500 cash bonus, restricted
shares of stock valued at $424,590, and a $901,913 "relocation" benefit for a total second-wave-
gratuity of $1,639,003; that Robinson had to have known that the payment ofthe second "rellcation"
benefit was duplicative and did not immediately return it to the Company.
g. $845,869 tax free gift to Scott Stevenson (Vice President of Sensorrziatic and
one of Kozlowski's "key managers") for no valid business reason. Similarly, current management
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knew that "only a few weeks after the unauthorized forgiveness and gross-up of Florida
loan liability" Kozlowski had granted Scott Stevenson a $312,500 cash bonus, restricted I shares of
stock valued at $424,590, and a $717,447 "relocation" benefit for a total second-wave-ratuity of
$1,454,537; that Stevenson had to have known that the payment of the second "relocation"" benefit
was duplicative and did not return immediately it to the Company.
80. As known co-conspirators to the secret fleecing of Tyco, the actions of e4ch of the
foregoing individuals should have been put under a microscope during the forensic inve' tigation.
In addition, the Company's mergers & acquisitions (Jeffrey Mattfolk Senior Vice Preside t of Tyco
International Inc. and Director Mergers & Acquisitions) and the books and records ofTyc Fire and.
Security Services (Jerry Boggess, President4) should have been scrutinized with a critical dye. This
is particularly true, given the fact that Breen's "first priority of Chief Executive Offijcer" was
purportedly to ascertain: "whether the same management mind-set that had led executivefs to seek
personal benefit at the expense of the Company might have led those same executives to ajttempt to
fraudulently or improperly inflate the Company's reported financial results." (December 130, 2002
Form 8-K).
4/ Tyco's September 17, 2002 Form 8-K states: "Mr. Boggess is currently President ofTyco's Fire and Security Services division. Mr. Boggess borrowed a total of $5,000,000 nrelocation loans to purchase property in Boca Raton in 1997. This loan was forgiven andgrossed-up as part of the TyCom Bonus in September 2000 discussed in the next section, whichhad not been approved by the Compensation Committee. Mr. Boggess also borrowed anadditional amount which was purportedly forgiven by Mr. Kozlowski in January 2002. Uponlearning that Mr. Kozlowski was not authorized to have forgiven this loan, Mr. Boggessrequested the reinstatement of the loan, with reversal of the related gross-up as if the loan had notbeen forgiven and he has now repaid this loan." The actions by Boggess were designed to avoidpossible criminal charges.
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81. This was not done. Instead of addressing the large fraud issues still haijnting the
Company's headquarters, Breen and FitzPatrick focused on a few limited frauds. Thely did not
undertake a review of the prior actions of the above noted individuals, and Breen and Fitzpatrick did
not undertake a critical scrutiny of the books and records of Tyco Fire and Security Services (as
evidenced by the re-restatement ofADT dealer income issue discussed above). This was
egregious because Breen and FitzPatrick knew that Kozlowski used the Company's Fire an4 Security
business segment to finance his personal non-business extravagances (December 31, 2001 Form 8-
K) ("rent expensive hotel accommodations for him in London, which cost about $110,000, for 13
days; an instance in which Mr. Kozlowski caused the same segment to employ his personal assistant
in London and provide her with an apartment, maintenance expenses , and other benefits from May
2001 to July 2002")
82. And, although Tyco had made more than 700 acquisitions during the period
1999-2002 (all ofwhich were suspect due to Jeffrey Mattfolk' s involvement), Breen and F
elected to cursorily review the accounting for only fifteen acquisitions (AMP, Surgical,
Sherwood, Mallinckrodt, Carlisle Plastics, Thomas & Betts, SSI, Raychem, Central Sprint ler, AFC
Cable, Scott Tech, Simplex, Sensormatic, and Wells Fargo) during this time period. 'E'his was
particularly egregious because Breen and FitzPatrick knew that creative merger and acquisition
accounting was known to have flourished in the Company's Fire and Security business segment as
evidenced by the following statement contained in the December 30, 2002 Form 8-K:
For example, in 1999 a controller for one of the Fire & Security business unifisprepared and gave a presentation to the subsidiary's operating managers relating towhat was entitled "Acquisition Balance Sheet Opportunities." It urged its audienceto "be aggressive in determining exposures; determine reserves with worst casescenario; have a strong story to tell regarding each reserve; book the reserves on the
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acquired company's financial system; use the owner for ideas; improve on yestimates." The presentation also told its audience to "be aggressive in determirthe reductions of the asset," and "create stories to back the reductions." With restto "transitioning the acquired company" by creating reserves to cover one-time cothe document provided "being aggressive in our estimates will allow us toaggressive in the cost we apply." It also provided, "keep the reserve descriptiwithin the accounting rules but stretch the expenditures that go in."
B. Additional Scienter Allegations Regarding PricewaterhouseCogRers
i. PwC Earned Millions from Tyco As ItTurned A Blind Eye To Tyco's Frauds
83. The SEC investigated PwC's role in the now infamous Tyco financial
frauds and concluded that Scalzo ignored numerous red flags during his tenure as the PvC audit
engagementpartner , recklessly failed to conduct audits in compliance with United States
Accepted Auditing Standards ("GAAS"), and issued materially false and misleading audit
opinions . Accordingly, the SEC ruled that (SEC Press Release 2003-95; August 13,
...multiple and repeated facts provided notice to Scalzo regarding the integrityTyco's senior management and that Scalzo was reckless in not taking appropri,audit steps in the face of this information. By the end ofthe Tyco annual audit forfiscal year ended Sept. 30, 1998, if not before, those facts were sufficient to oblig-,Scalzo, pursuant to generally accepted auditing standards (GAAS), to reevaluate trisk assessment of the Tyco audits and to perform additional audit procedur,including further audit testing of certain items (most notably, certain executibenefits, executive compensation, and related party transactions). Scalzo did not tosufficient steps in these regards. Accordingly, Scalzo recklessly failed to conduct taudits in accordance with GAAS. The Order, therefore, finds that Scalzo engagedimproper professional conduct. The Commission denies him the privilegepracticing before the Commission as an accountant.
84. PwC, the beneficiary of Scalzo's misdeeds, earned tens ofmillions of dollars in fees
from Tyco on an annual basis. For example , as disclosed in a January 28, 2002 Form D^F 14A,
during 2001 PwC was paid:
$13.2 million for auditing services.
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b. $3.6 million for design and implementation ofa financial informatign system.
c. $18.1 million for tax-related services.
d. $9.8 million non-financial audit services.
e. $6.4 million for statutory audit work in non-U. S. countries.
85. PwC's non-audit work has, in the past, raised concerns in the investment community.
For example, a February 22, 2002 article in The Boston Globe noted that the Marco CInsulting
Group ("Marco"), a Chicago investment consultant holding 6.3 million Tyco shares, urged Tyco to
cease hiring PwC for the non-audit services. Marco noted that in 2001 PwC received rlore than
three times more for consulting work than it did for audit work. Marco consultant Greg
was quoted as stating "[t]his has to raise a question, how independent is the audit?" Despito this call
for an end to an apparent incestuous relationship, PwC continued to reap the benefits
non-audit work for Tyco.
86. According to information contained in a Form PRE 14A filed with thel SEC on
January 22, 2003, during 2002 PwC was paid:
a. $16.3 million for services rendered for the annual audit ofTyco's conIrolidated
financial statements for fiscal 2002 and the quarterly reviews of the financial statements included
in Tyco's Quarterly Reports on Form 10-Q.
b. $2.7 million for services rendered in connection with the dlsign or
implementation of hardware or software systems that aggregate source data or generate information
that is significant to the financial statements taken as a whole.
c. $11.6 million for tax-related services.
-39-
d. $11.3 million for non-financial statement audit services such as due diligence
procedures associated with mergers and acquisitions, accounting consultation, SEC revi ws and
registration statement-related work, benefit plan audits, etc.
e. $9.0 million for statutory audit work in non-U.S. countries unrelated to the
financial statement audit.
87. With these inordinate fees at stake, it is easy to understand why Scalzo and PwC
turned a blind eye to the obvious frauds being perpetrated at Tyco, and functioned as a p id agent
who indiscriminately blessed all of Tyco's financial statements without performing even the most
rudimentary of audit procedures. These frauds and accounting machinations that Scalzo nd PwC
turned a blind eye to are described below and provide added indicia of PwC's scienter.
ii. PwC Allowed Kozlowski and Swartz ToAbuse Tyco' s KELP Program
88. On Scalzo's and PwCs watch, Kozlowski and Swartz granted themselves undreds
of millions of dollars of low interest and no-interest loans from Tyco which were not disclosed in
the Company's financial statements or in filings with the SEC. Most of Kozlowski's and wartz's
improper Tyco loans were obtained through abuse ofTyco's Key Employee Corporate Loan rogram
(the "KELP") made possible by a poorly designed and woefully deficient system ofinternal pontrols.
(See: Tyco's September 17, 2002 Form 8-K; Tyco's December 30, 2002 Form 8-K; the SE 's Press
Release 2003-95 dated August 13, 2003; the SEC's Accounting and Auditing Enforcement Release
No. 1627 dated September 12, 2002; the SEC's Accounting And Auditing Enforcement Release No.
1839 dated August 13, 2003; and the SEC's Complaint against Kozlowski, Swartz and Belnick as
filed in the United States District Court, Southern District of New York).
-40-
89. According to Tyco's proxy statements, the KELP, established by Tyco in 983, and
subsequently amended, was "designed to encourage ownership of Tyco common hares by
executives and other key employees." The purpose of the KELP was to provide low intel est loans
to enable Tyco executives and employees to pay taxes due as a result of the vesting of ownership of
shares granted under Tyco's restricted share ownership plan. The plan itself, as filed with the SEC,
explicitly described its narrow purpose:
[U]nder the Program, loan proceeds may be used for the payment of federal incctaxes due upon the vesting of Company common stock from time to time under1983 Restricted Stock Ownership Plans for Key Employees, and to refinance o1existing outstanding loans for such purpose.
90. During PwC's reign as Tyco's independent auditor, Kozlowski an[ Swartz
improperly obtained hundreds of millions ofdollars in KELP loans which they used for purposes not
legitimately authorized by the KELP.
91. From 1997 to 2002, Kozlowski took KELP loans aggregating approximately $270
million from Tyco, even though he only used approximately $29 million of those fixndsl to cover
taxes due as a result of the vesting of his Tyco stock.
92. Kozlowski improperly took and used the remaining approximately $241 npillion of
supposed KELP loans (or roughly ninety percent of the approximately $270 million he had taken
from Tyco) for impermissible and unauthorized purposes, including funding an extravagant lifestyle.
93. For example, with his KELP loans, Kozlowski amassed millions ofdollars iia fine art,
yachts, and estate j ewelry, as well as an apartment on Park Avenue and a palatial estate in Nantucket.
He also used the KELP to fund his personal investments and business ventures.
-41-
94, During that same time period, from 1997 to 2002, Swartz took KELP loans
aggregating approximately $85 million dollars from Tyco, even though he only used approximately
$13 million worth of those funds to cover taxes due from the vesting of his Tyco stock.
95. Swartz improperly took and used the remaining $72 million ofsupposed LP loans
(or roughly eighty-five percent) for impermissible and unauthorized purposes.
96. For example, Swartz funded millions of dollars ofhis personal investments, business
ventures, real estate holdings and trusts.
iii. PwC Allowed Kozlowski and Swartz to Abuse
Tyco' s Relocation Loan Program
97. Kozlowski and Swartz also abused Tyco's relocation loan program to
enrich themselves.
98. This interest-free loan program, established by Tyco in 1995, was designed to assist
Tyco employees who were required to relocate from New Hampshire to New York, when Tyco
moved its corporate offices from New Hampshire to New York City, and, subsequently, to assist
Tyco employees who were required to relocate to Boca Raton, Florida when Tyco move its U.S.
operations there. The program did not provide for relocation loans for moves to any otheill location
or for any other purpose.
99. From 1996 to 2002, Kozlowski obtained Tyco relocation loans aggregating
approximately $46 million. Kozlowski used $18 million of those loans to purchase a waterfront
compound in Boca Raton. Kozlowski used the remaining $28 million ofpurported "relocation loans"
for purposes which were not within the scope of the relocation loan program.
-42-
100. For example, Kozlowski used approximately $21 million of "relocation" ;
various other purposes, including the purchase of prestigious properties in New
oans for
Nantucket and Connecticut. Kozlowski even used approximately $7 million of Tyco's funds to
purchase a Park Avenue apartment for his wife from whom he had been separated for m4ny years
and whom he subsequently divorced.
101. Swartz obtained more than $32 million under the relocation loan
102. With those funds, Swartz purchased a $6.5 million apartment on New Yotk City's
Upper East Side and a $17 million waterfront compound in Boca Raton, Florida. Swartziused the
remaining $9 million for purposes that were not authorized by the relocation loan program,
the purchase of a yacht and the funding of real estate investments.
103. On numerous occasions , Kozlowski and Swartz arbitrarily classified and re lassified
their indebtedness to Tyco between the KELP and relocation loan program, without any rigard for
the legitimate and authorized purposes of the two loan programs.
104. For example, Kozlowski initially funded his palatial estate in Nantucket tinder the
relocation loan program and subsequently reclassified the entire amount of that indebtedness to the
KELP. Similarly, Swartz initially funded the purchase of his New York City apartment tinder the
KELP and subsequently reclassified the entire amount to the relocation loan program.
105. Kozlowski and Swartz pocketed tens of millions of dollars through self-engineered
forgiveness of Tyco loans and non-disclosed bonus plans.
106. Taking advantage of a poorly designed and woefully deficient system of internal
controls and an audit firm (PwC) that blinded itself to improprieties, Kozlowski and Swartz
authorized transactions by which tens ofmillions of dollars oftheir KELP loans and relocation loans
-43-
were forgiven and written off Tyco's books. They also directed the acceleration of the vesting of
Tyco common stock for their benefit.
107. In August of 1999, Kozlowski authorized, and Swartz caused to be recorded ^n Tyco's
books and records, a $25 million loan forgiveness against Kozlowski's outstanding KELP balance
and a $12.5 million credit against Swartz's outstanding KELP balance. Although the "LP loan
forgiveness was tantamount to a $37.5 million payment from Tyco to Kozlowski and Sw*z, these
transactions were never disclosed to investors as part of Kozlowski's or Swartz's
compensation in Tyco's annual reports on Forrn 10-K and proxy statements.
108. Continuing to take advantage of a poorly designed and woefully deficient s' stem of
internal controls and an audit firm (PwC) that blinded itself to improprieties, in Septemberlof 2000,
Kozlowski, through THE Management Corp. ("TME"), a subsidiary ofTyco, engineered a
whereby Tyco covertly forgave tens ofmillions of dollars of "relocation loans" that he, Swartz, and
others owed. To receive these benefits, all that each had to do was execute a letter agreement in
which they promised not to disclose the loan forgiveness "to anyone other than [their] financial, tax
or legal advisors."
109. Under the September 2000 relocation loan forgiveness program, Kozlowski eceived
$32,976,068 in forgiven relocation loans and Swartz received $16,610,687 in forgiven r location
loans. Although the relocation loan forgiveness was tantamount to an additional $49 586,755
payment from Tyco to Kozlowski and Swartz, these transactions were never disclosed to iivestors
as part of Kozlowski's or Swartz's executive compensation in Tyco's annual reports on Form 10-K
and proxy statements.
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110. In addition, Kozlowski, together with Swartz, abused the poorly designed and
woefully deficient system of internal controls (knowing that PwC would blinded I itself to
improprieties), to offset the cost ofthe relocation loan forgiveness program against the gai4 from an
unrelated initial public offering of, TyCom Ltd., a Tyco subsidiary.
iv. PwC Blinded Itself To Secret CompensationReceived By Tyco 's Top Executives
111. In December of 2000, Kozlowski and Swartz engineered another program whereby
Tyco paid them and certain other favored employees bonuses comprised of cash, Tyco common
stock, and/or forgiveness of relocation loans.
112. Pursuant to that program, Kozlowski received 148,000 shares ofTyco comrr on stock,
a cash bonus of $700,000, and $16 million in relocation loan forgiveness. Swartz receiv d 74,000
shares of Tyco common stock, a cash bonus of $350,000, and $8 million in reloca ion loan
forgiveness. None of these payments were disclosed as part of Kozlowski's and Swartz's ^xecutive
compensation in Tyco's annual reports on Form 10-K and proxy statements.
113. Once again taking advantage of a poorly designed and woefully deficient ystem of
internal controls and knowing that PwC would blinded itselfto improprieties, Kozlowski aid Swartz
directed others to falsify Tyco's books and records to bury this secret compensation by offsetting the
costs of the December 2000 program against an unrelated gain realized on the disposal if a Tyco
subsidiary.
114. In June of 2001, Kozlowski and Swartz directed the acceleration of the vesting of
Tyco common stock for the benefit ofthemselves and certain other favored employees. As a result,
Kozlowski and Swartz realized profits of approximately $ 8 million and $4 million, respectively.
-45-
These profits were never disclosed as part ofKozlowski's and Swartz's executive compeisation in
Tyco' s annual reports on Form 10-K and proxy statements.
115. In their ongoing abuse of the poorly designed and woefully deficient ^ystem of
internal controls and knowing that PwC would blinded itselfto improprieties , Kozlowski aid Swartz
once again directed others to falsify Tyco's books and records to bury this secret compensation by
offsetting the cost against an unrelated gain on the sale of common stock of a Tyco
116. Kozlowski and Swartz also engaged in additional undisclosed, s
non-arms -length transactions with Tyco or its subsidiaries.
117. In 2000, Kozlowski arranged for THE to purchase his house in New Hampshire for
$4.5 million, three times the property's apparent fair market value. This self-dealing transa4tion was,
also, not disclosed to investors.
118. In 2000, Kozlowski purchased the Park Avenue apartment from Tyco for the same
price that Tyco had paid for it eighteen months earlier, without a contemporaneous appraisal
justifying the absence of any increase in market value. This transaction was also concealed from
investors.
119. Kozlowski enjoyed numerous and extensive perquisites from Tyco that were
concealed from investors.
120. For example, in 2000, Kozlowski caused Tyco to purchase in Kozlowski's name (as
nominee) an apartment on Fifth Avenue in New York City (for which Tyco paid over $31 million).
In 2001, after a major renovation to that apartment, Kozlowski moved into the Fifth Avenue
apartment and lived there rent-free.
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121. Kozlowski also directed millions of dollars of charitable contributions in his own
name (including contributions to Seton Hall University, Nantucket Historical Association) Berwick
Academy, and Columbia University) using Tyco funds. Moreover, Kozlowski used Tyco (1
aircraft for personal use at little to no cost.
122. Swartz also received numerous perquisites from Tyco that were not disFlosed to
investors. In 2000, for example, Swartz caused Tyco to purchase an apartment in Swartz' name on
New York City's Upper East Side. Swartz then moved into the apartment and lived thererent-free
(a perquisite worth in excess of $18,000 a month). Swartz also used Tyco's corporate aircraft for
his own personal use at little to no cost.
123. From 1998 to 2002, Belnick received Tyco relocation loans of over $14 million.
124. For years prior to his employment at Tyco , Belnick maintained his professioial office
in midtown Manhattan , only blocks from Tyco' s headquarters at the time . When Belni^k joined
Tyco, he demanded and received a loan of approximately $4 million to "relocate" to New York City
even though he was ineligible for the plan because he had not previously worked for Tyco let alone
worked for Tyco's New Hampshire headquarters , as required by the terms of the plan) and already
owned a house in Westchester County, a suburb just outside of New York City. Belnicklused the
loan to buy and renovate a new apartment on Central Park West in Manhattan.
125. Belnick used the remaining $10 million dollars in loans to purchase real estate in Park
City, Utah. In September of 2001, Belnick received the vast majority of the loan, purs.ant to a
promissory note with TME, a Tyco subsidiary . The loan was ostensibly granted under Tyco's
relocation loan program to assist Belnick with a "relocation" to Park City, Utah, although Tyco never
had a corporate presence in Utah, let alone a loan program that paid for employees to relocate there.
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126. In fact, at the time of his supposed relocation, Belnick already owned a $2 million
home in Park City, Utah. After receiving the "relocation " loan, Belnick and Kozlowski agreed that
Tyco should pay him a $19,200 annual allowance for the "dedicated Tyco office in [his ] Utdh home."
Tyco agreed and Belnick pocketed the proceeds, which Tyco prepaid through Octo
These facts were not disclosed to Tyco shareholders.
v. PwC Closed Its Eyes To ObviousUndisclosed Related Party Transactions
127. In late 2000, Walsh recommended that Tyco consider acquiring The CIT
of 2002.
,Inc.
("CIT"). Thereafter, Kozlowski indicated that Tyco was interested in pursuing this tra]saction.
Accordingly, in early 2001, Walsh arranged a meeting between Kozlowski and Albert R.! Gamper,
Jr. ("Gamper"), CIT's Chief Executive Officer.
128. After the first meeting between Kozlowski and Gamper, Kozlowski proposed to pay
Walsh an investment banking or finder's commission for his services if the transadtion was
successfully completed.
129. When the transaction was submitted to the Board, Walsh participated in 4nd voted
in favor of the transaction but Walsh intentionally did not disclose to the Board that he would receive
a substantial fee in connection with the transaction.
130. The terms and conditions of the Tyco/CIT merger were set forth in the Afreement
and Plan of Merger dated March 12, 2001. In the section of the Agreement and Plan of Merger that
icontained the representations and warranties of Tyco , Tyco represented that, other than Lehman
Brothers and Goldman, Sachs & Co. (the investment bankers that represented Tyco in the Tyco/CIT
merger): "...there is no investment banker, broker, finder or other intermediary that has been retained
-48-
by or is authorized to act on behalf of [Tyco] who might be entitled to any fee or commission from
[Tyco]...in connection with the transactions contemplated by this Agreement."
131. On April 13, 2001, Tyco filed with the SEC a registration statement on Fo S-4 (the
"Registration Statement") for the securities related to the contemplated merger between [yco and
CIT. The Agreement and Plan of Merger was incorporated by reference in, and attached to, the
Registration Statement.
132. In his capacity as a director ofTyco, Walsh signed the Registration Statemett. At the
time that he signed , Walsh knew that the Registration Statement contained a material
misrepresentation regarding the payment of a "finder's fee" because he knew that he stood to obtain
a substantial fee if the transaction was consummated.
133. After the transaction was consummated, pursuant to his prior agreemlQnt with
Kozlowski to receive a fee, Kozlowski caused Tyco to pay Walsh an undisclosed $20 million
"finder's fee" in the form of $10 million in cash and a $10 million charitable contribution to a
foundation chosen by Walsh.
134. GAAP, Financial Accounting Standards Board ("FASB") Statement Of Financial
Accounting Standards No. 57, Related PartDisclosures -- "FASB Statement No. 57"1 defines
related parties as follows:
Affiliates of the enterprise; entities for which investments are accounted for by theequity method by the enterprise; trusts for the benefit of employees, such as pensionand profit-sharing trusts that are managed by or under the trusteeship ofmanagement;principal owners of the enterprise; its management; members of the immediatefamilies of principal owners of the enterprise and its management; and other partieswith which the enterprise may deal ifone party controls or can significantly influencethe management or operating policies of the other to an extent that one of thetransacting parties might be prevented from fully pursuing its own separate interests.Another party also is a related party if it can significantly influence the management
-49-
or operating policies of the transacting parties or if it has an ownership interest in oxjteof the transacting parties and can significantly influence the other to an extent thl tone or more of the transacting parties might be prevented from fully pursuing its ovonseparate interests.
135. Pursuant to this definition, Walsh, Kozlowski, Swartz and Belnick were related
parties; a fact which is confirmed in note 17 to the audited financial statements which are ontained
in Tyco's September 30, 2002 Form 10-K.
136. According to GAAP (FASB Statement No. 57):
Reliability of financial information involves "assurance that accounting measur4srepresent what they purport to represent." Without disclosure to the contrary, the eis a general presumption that transactions reflected in financial statements have beenconsummated on an arms-length basis between independent parties. However, th tpresumption is not justified when related party transactions exist because herequisite conditions of competitive, free-market dealings may not exist. Because .tis possible for related party transactions to be arranged to obtain certain resultsdesired by the related parties, the resulting accounting measures may not representwhat they usually would be expected to represent.
137. Because of this, GAAP (FASB Statement No. 57) states that:
Information about transactions with related parties is useful to users of financTstatements in attempting to compare an enterprise's results of operations andfinancial position with those of prior periods and with those of other enterprises. fthelps them to detect and explain possible differences. Therefore, information aboittransactions with related parties that would make a difference in decision makingshould be disclosed so that users of the financial statements can evaluate the}rsignificance.
138. As noted in FASB Statement No. 57, "as part ofAccounting Series Release No. 280,
General Revisions of Regulation S-X, the Securities and Exchange Commission integated the
disclosure requirements ...pertaining to related party transactions into Regulation S-X." In addition,
FASB Statement No. 57 mandates that "financial statements shall include disclosures ofmaterial
related party transactions " and that such disclosures shall include:
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A description of the transactions, including transactions in which no amountsnominal amounts were ascribed, for each ofthe periods for which income statemeare presented, and such other information deemed necessary to an understandingthe effects of the transactions on the financial statements .
139. In contravention of the provisions of FASB Statement No. 57, Tyco's
financial statements that were disseminated to the investing public failed to disclose the
that was necessary to understand the effects of the Company's related party transactions qn Tyco's
financial statements.
140. Such disclosure is necessary to clarify the investment community's understknding of
the operations of the Company.
141. As discussed herein , related party transactions between the Company and its officers
and directors were arranged to obtain certain results desired by the related parties. In accounting for
these transactions, the resulting accounting measures did not represent what the investiig public
reasonably expected them to represent, at least in part, because the economic substance of the
transactions were ignored for financial accounting purposes. Consequently, the overall
created by the financial statements was inconsistent with the business realities of the
financial position and operations. Accordingly, the Company's financial statements violated FASB
Statement of Financial Accounting Concepts No. 2 which states (in paragraph 160) that:
The principle that the quality of reliability and, in particular , of representationalfaithfulness leaves no room for accounting representations that subordinate substanceto form.
142. When auditing the Company' s financial statements and rendering its opinions, PwC
either knowingly or recklessly failed to consider GAAS, as set forth in the Codification Of
Statements On Auditing Standards ("AU"), which states (AU Section 334) that:
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... established accounting principles ordinarily do not require transactions with relatTdparties to be accounted for on a basis different from that which would be appropna^teif the parties were not related . The auditor should view related party transactionswithin the framework of existing pronouncements , placing primary emphasis on theadequacy of disclosure . In addition, the auditor should be aware that the substaneof a particular transaction could be significantly different from its form and thatfinancial statements should recognize the substance of particular transactions ratherthan merely their legal form.
143. GAAS (AU Section 334) provides guidance on examining related-party tra sactions
that have been identified by the auditor . It states that, in determining the scope of wprk to be
performed with respect to possible transactions with related parties, the auditor should:
a. Obtain an understanding ofmanagement responsibilities and the relRtionship
of each component to the total business entity.
b. Consider controls over management activities.
c. Consider the business purpose served by the various components of the
business entity.
144. Significantly, this section of the authoritative auditing literature points out the fact
that the auditor should be cognizant of the fact that : "Experience has shown, however, thatibusiness
structure and operating style are occasionally deliberately designed to obscure relaed party
transactions."
145. GAAS (AU Section 334) states that "the auditor should place emphasis do testing
material transactions with parties he knows are related to the reporting entity." It notes that "the
auditor should consider obtaining representations from the entity's senior management and its board
of directors about whether they or any other related parties engaged in any transactions with the
entity during the period" and it specifically sets forth the following procedures which are to be
-52-
performed in determining the existence of related party transactions and the purpose, nature, and
extent of these transactions and their effect on the financial statements:
a. Evaluate the company's procedures for identifying and properly accounting
for related party transactions.
b. Request from appropriate management personnel the names of 11 related
parties and inquire whether there were any transactions with these parties during the pen d.
c. Review the minutes of meetings of the board of directors and executive or
operating committees for information about material transactions authorized or discussed at their
meetings.
d. Review proxy and other material filed with the Securities and xchange
Commission and comparable data filed with other regulatory agencies for information abou^ material
transactions with related parties.
e. Review conflict-of-interests statements obtained by the compan from its
management.
f. Consider whether transactions are occurring, but are not bei>ag given
accounting recognition, such as receiving or providing accounting, management or otheii services
at no charge.
g. Review accounting records for large, unusual, or nonrecurring transactions
or balances, paying particular attention to transactions recognized at or near the end ofthe Teporting
period.
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h. Review invoices from law firms that have performed regular or special
services for the company for indications of the existence of related parties or related party
transactions.
i. Review confirmations of loans receivable and payable for indidations of
guarantees. When guarantees are indicated, determine their nature and the relationships, if any, of
the guarantors to the reporting entity.
j. Obtain an understanding of the business purpose of the transactio .
k. Examine invoices, executed copies of agreements, contracts, and other
pertinent documents, such as receiving reports and shipping documents.
1. Determine whether the transaction has been approved by the board o 'directors
or other appropriate officials.
M. Test for reasonableness the compilation of amounts to be disclosed, or
considered for disclosure, in the financial statements.
n. Inspect or confirm and obtain satisfaction concerning the transfer ility and
value of collateral.
146. Having performed these procedures, PwC identified and ignored the fact that the
following related party transactions (and others particularized herein) occurred and ^ere not
disclosed in the Company's financial statements:
Kozlowski improperly borrowed approximately $29,756,000 in non-qualifying
relocation loans to purchase land and construct a home in Boca Raton, Florida during the yEars 1997
to 2000.
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b. Kozlowski improperly borrowed approximately $7,012,000 innon-qualifyingi
interest-free Company loans to purchase a $7 million Tyco-owned apartment at 610 Par^ Avenue,
New York City in 2000, at depreciated book value and without appraisals, which Kozlowski deeded
to his ex-wife a few months later.
c. Kozlowski improperly rented an apartment at 817 Fifth Avenue, New York
City, with an annual rent of $264,000 paid for by the Company, from 1997 to 2001.
d. Kozlowski improperly sold his house at 10 Runnymede, North HampIton, New
Hampshire to the Company in 2000 without appraisals for an amount approximately three times its
market value; less than 24 months later, the Company wrote down this asset by approximately $3
million.
C. Kozlowski improperly caused Tyco to purchase a second apartment for his
use (with Kozlowski as nominee owner) at 950 Fifth Avenue, New York in 2001 for $16. million,
and then caused Tyco to spend $3 million in improvements and $11 million in furnishings for that
apartment.
f. Kozlowski improperly received "gross-up" benefits to avoid having to pay any
state income tax liability incurred after relocating to New York.
g. Kozlowski improperly caused the Company to pay for expensive hotel
accommodations for his personal use, in London, at a cost of approximately $110,000 fora 13 days.
h. Kozlowski improperly caused the Company to employ his personal assistant
in London and provide her with an apartment, maintenance expenses, and other benefits from May
2001 to July 2002.
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Swartz improperlyused $7,668,750 in interest-free Company loans fo finance
100% of the purchase price of two properties : one at 24 Straw's Points Road, Rye, New
and another in the Trump International Hotel and Tower Condominium, 1 Central Park West, New
York.
Swartz improperly used $20,992,000 in interest-free Company loins under
an unauthorized Florida relocation program.
k. Swartz improperly used $4,437,175 in interest-free Company lo s for the
acquisition of other properties that were not authorized by any relocation program.
1. Belnick improperly used $4,217,000 of interest- free Company loans from
September 1998 through May 2001 for the purchase and improvement of a cooperative apartment
in New York City at 300 Central Park West ("New York relocation loan").
M. Belnick improperly caused the Company to pay his rent for severImonths
while his new apartment was being renovated.
n. Belnick improperly borrowed $10,418,599 in interest-free loans, filom 2001
through March 2002, to purchase land and renovate a $10 million ski chalet at 3468 W'lest Crest
Court, Park City, Utah.
o. Belnick improperly charged Tyco $1600 per month for his home office located
in the Utah home.
p. Walsh improperly received a $20 million fee ($10 million of whicin went to
Walsh with the balance going to a charity of which Walsh is trustee) for making introductions which
led to a Tyco acquisition in June 2001.
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q. The use of Company assets (principally cash) to fraudulently enrich
Kozlowski, Swartz, Belnick and Walsh was concealed in the Company's financial s4atements
through misclassifications and improper financial reporting.
147. The books and records ofthe Company, which were openly available to Pw , plainly
reflected the nature of the foregoing improper and undisclosed related party transactions and the
amounts involved. There was no concealment of the fact that the Company and Kozlowski end other
senior officers repeatedly engaged in related party transactions solely for the benefit of
and other senior officers, at the expense of the Company, and in a way that did not addiance the
interests of the Company in any colorable way.
148. For example, the books and records of the Company plainly disclosed th fact that
a Company apartment was provided to Kozlowski in New York at 950 Fifth Avenue, that Kozlowski
caused Tyco to purchase fine art worth millions of dollars and failed to pay sales taxes the eon, and
that Kozlowski purchased and decorated the New York apartment with appointments and furnishings
lacking any legitimate business justification, including a shower curtain for $6,000, a dog!umbrella
stand for $15,000, a sewing basket for $6,300, a traveling toilette box for $17,100, a gilt metal
wastebasket for $2,200, coat hangers for $2,900, two sets of sheets for $5,960, a notebook for
$1,650, and a pin cushion for $445.
149. Additionally, the books and records of the Company plainly disclosed the fact that
Kozlowski caused Tyco to pay for most of the costs of a $2.1 million birthday party for Kozlowski's
second wife at the Hotel Cala di Volpe in Sardinia; a party which featured an ice sculpture of
Michelangelo's David with vodka streaming from his penis into crystal glasses and an exploding
birthday cake with a replica of a woman's breasts on top. These books and records also plainly
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disclosed the fact that Kozlowski used the Company's funds to finance his personal (non-^usiness)
extravagances. For example, the Company's December 30, 2002 Form 8-K describes how
Kozlowski caused the Company to "rent expensive hotel accommodations for him in London, which
cost about $110,000, for 13 days; an instance in which Kozlowski caused the same segment to
employ his personal assistant in London and provide her with an apartment, maintenance
and other benefits from May 2001 to July 2002".
150. Similarly, the books and records of the Company openly reflected the pact that,
although the notes to Tyco's consolidated financial statements included in the companyjs annual
report on Form 10-K for each Tyco fiscal year from the fiscal year ended September 130, 1997
through the fiscal year ended September 30, 2001 stated that loans under the KELP "are
the payment of taxes upon the vesting of shares granted under [the company's] Restrict.d Stock
Ownership Plans", KELP loans were:
a. not being used for the stated purpose.
b. vastly in excess ofthe taxes which they were intended to enable key j
to pay.
c. used as a revolving line of credit by key officers of the Company.
151. The SEC, after an investigation of PwC's role in the Tyco financial stateme t frauds,
confirmed these facts stating (SEC Accounting And Auditing Enforcement Release No. 1839):
For the fiscal year 1997 audit, the working papers concerning that statement contaiitwenty-six-pages of reports prepared by the company, listing the activity in thevarious KELP accounts ofTyco employees. Three ofthose twenty-six pages set forththe KELP account activity for L. Dennis Kozlowski (then the company's ChiefExecutive Officer and Chairman) from February 1, 1987, through September 39,1997. Most of the 1997 line items for the Kozlowski account also include a briefdescription for each such item, and eighteen carry descriptions that are immediately
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recognizable as not being for the payment of taxes on the vesting of restricted stocFor example, one item reads "WINE CELLAR," another reads "NEW ENG WINEanother "BMW REG/TAX," another "ANGIE KOZLOWS," and thirteen read eith"WALDORF," "WALDORF RENT," "WALDORF EXPEN," "WALDORF RETA," or WALDORF RENTS." For each of the Tyco fiscal years from its fiscal yeended September 30, 1998, through its fiscal year ended September 30, 2001, tPwC audit working papers continued to include schedules for the KELP accountsTyco employees. Although those schedules did not include Kozlowski activity li:item descriptions, the schedules nevertheless continued to show Tyco's most seniofficers utilizing the KELP with a frequency that is impossible to reconcile with tipayment of taxes on the vesting of restricted stock. In fact, the rate ofKELP activifor those officers was due to their use of the program as a revolving line of creditand should have led the PwC audit team to inquire further as to whether the loacould possibly be authorized... Scalzo's own desk files contain at least one additiondocument that clearly reflects the KELP being used for purposes other than t]payment of taxes on the vesting of restricted stock.
152. The SEC, after an investigation ofPwC's role in the Tyco financial statemeit frauds,
confirmed that none of the above particularized facts were concealed from PwC statiig (SEC
Accounting And Auditing Enforcement Release No. 1839):
A principal vehicle ofexecutive compensation and related party transactions at TycPwas the KELP loans to its senior officers. Nevertheless, the PwC audit team did notpursue troublesome facts regarding KELP. The PwC working papers containerdocuments that contradicted the KELP financial statement footnote they weleostensibly intended to support. Scalzo knew, and documents contained in his owdesk files showed, that KELP loans had been used to exercise tens ofmillions ddollars worth ofstock options rather than to pay taxes on the vesting ofrestrictestock Failing to reevaluate audit risk in this area, Scalzo took nofurther steps. B edid not perform, nor did he direct PwC personnel to perform, any audit steps tdetermine whether KELP loans made to Tyco's top officers, in fact, were consistentwith the program purpose stated in the financial statement footnote. He did nol tinform the audit committee of Tyco 's Board of Directors that Tyco's most seniorofficers had used KELP loans for non-program purposes.
Another principal area of Tyco executive compensation and related partransactions was that of non-interest-bearing loans extended to Tyco's seniormanagement. Here, also, the audit team failed to respond to troublesome facts andevents. Scalzo was aware of tens of millions of dollars in non-interest-bearing loansto Tyco's top two officers. For each of the Tyco fiscal years 1999-2001, PwCsrecommendation that these loans be disclosed was rejected. Scalzo raised the issuewith the principal beneficiaries ofthe loans: Kozlowski and Swartz. Swartz told
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Scalzo that disclosure was not needed because the loans were not materialTyco's financial statements. Scalzo considered that statement and the impactnon-disclosure on thefinancial statements. Scalzo did not reevaluate audit riskthis area, and he took no additional audit steps regarding the propriety adisclosure of the loans or their authorization, other than to review and consiu
management's draft financial statements. He did not review the PwC worldpapers on the use ofthe loans. He did not insist on separate disclosure ofthe loain Tyco's financial statements, and he did not inform the audit committee of texistence ofthe non-interest-bearing loans.
Scalzo was aware of tens of millions of dollars of these non-interest-bearing lo
to Tyco's top two officers. By the time of the fiscal year 1999 audit, Scalzo knew,
example, that Kozlowski had $35.5 million, and that Swartz had $8 million, of s,
loans. The loans ostensibly were granted under Tyco's relocation loan program;
were to be used to assist with the purchase of real estate by Tyco employees v
were required to relocate to Tyco's offices in New York City and Boca Rat
Florida. These loans were recorded on the books and records of the company ;
were reviewed as part of the audit process. [emphasis added]
153. GAAP (Accounting Research Bulletin No. 43, Restatement and Rev}isi
Accounting Research Bulletins ) mandates that, "notes or accounts receivable due from
employees, or affiliated companies must be shown separately and not included under
heading such as notes receivable or accounts receivable."
154. Accordingly, PwC was specifically required to audit the above
purpose of ascertaining whether (i) Tyco 's financial statements contained the required
disclosure and whether (ii) the amounts in the disclosures were correct.
I officers,
general
for the
I separate
155. Moreover, as specified above, GAAP (FASB Statement No. 57) states that
"information about transactions with related parties that would make a difference in decision
making should be disclosed so that users ofthe financial statements can evaluate their significance."
The GAAS requirements with regard to the disclosure of related party transactions are very clear:
For each material related party transaction (or aggregation of similar transactions) qr
common ownership or management control relationship for which FASB Statement
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No. 57 requires disclosure, the auditor should consider whether he has obtain(
sufficient competent evidential matter to understand the relationship of the partii
and, for related party transactions, the effects of the transaction on the financi
statements. He should then evaluate all the information available to him concernir
the related party transaction or control relationship and satisfy himself on the bas
of his professional judgment that it is adequately disclosed in the financi
statements. (AU Section 334)
vi. The SEC's Investigation Showed That PwC
Improperly Succumbed to Tyco Management
156. The SEC, after an investigation ofPwC's role in the Tyco financial
s
frauds,
confirmed that PwC understood the relationship of the parties, the nature of the related party
transactions, and the effects of these transactions on the financial statements, but acquiesced to the
desire ofdefendants to conceal these facts from the investing public (SEC Accounting And kuditi
Enforcement Release No. 1839):
Pursuant to the firm's standard audit procedures, the PwC audit team for the T
audits recommended that Tyco disclose in its periodic reports the existence of tl;
non-interest-bearing loans. When Scalzo raised the issue with the print:
beneficiaries ofthe loans (Kozlowski and Swartz), Swartz told Scalzo that disclos
was not needed because the loans were not material to Tyco's financial stateme
and Swartz refused to make the disclosure. The resistance to such disclosure, togel
with other facts and events discussed herein, provided notice to Scalzo regarding
character and integrity of Tyco senior management.
vii. PwC Ignored Nearly $100 Million In Undisclosed And
Unapproved "Bonuses" for Relocation Loan Forgiveness
157. In September 2000, Kozlowski caused Tyco to pay an unapproved bonus to 51
employees who had relocation loans with the Company. The bonus was calculated to fo give the
relocation loans of all 51 employees, at a total cost to the Company of $56,415,037, and to pay
compensation sufficient to discharge all of the tax liability due as a result of the forgiveness ofthose
loans. This action was ostensibly related to the successful completion of the TyCom Initial Public
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Offering (In July 2000 , Tyco successfully completed an initial public offering of
fourteen percent of the outstanding common stock of its previously wholly-owned supsidiary,
TyCom Ltd ., which served as the holding company for Tyco' s undersea fiber optjic cable
communications business). The total gross wages paid by the Company in this loan forgiveness
program were $95,962,000, of which amount Kozlowski received $32,976,000 and, Swartz
$16,611,000.
158. These benefits were not approved by the Compensation Committee or the poard ofi
Directors, and PwC either knew and ignored or recklessly failed to know this fact.
159. Mark Foley, a Vice President of Finance prepared a memorandum signed by Swartz
that explained the accounting treatment for the near-$100 million charge. The memo, which was not
concealed from PwC, stated:
The sale of 14% ofTyCom generated a one-time gain ofapproximately $1.76 billioi
on the books of Tyco. We have decided to award special bonuses to various Tycp
employees for their efforts over the past few years in enhancing the value of TyCorinand thereby contributing to this gain. Selected employees will receive their bonus iTz
the form ofcash, forgiveness of relocation loans, and/or Tyco Common shares undez
Tyco's restricted stock program. (September 17, 2002 Form 8-K)
160. As a result of this accounting treatment, this extraordinary near-$ 100 millio charge
was allocated to several different accounts and appeared in the general ledger and materially
impacted the Company' s financial statements as a (September 17, 2002 Form 8-K):
a. $44,602,065 Tycom Offering Expense as a component of "Other (Income)
Expense" in the Company's income statement.
b. $11,772 ,973 offset to previous over accruals of General & Administrative
Expenses in the Company' s balance sheet.
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c. $40,977,616 adjustment to accrued federal income tax, a balance sheet
account used for corporate income taxes.
161. As noted above, PwC was required by GAAS (AU Section 334) to have reviewed the
minutes of meetings of the board ofdirectors and executive or operating committees. Acdordingly,
PwC knew and ignored or was reckless in not knowing that the bonuses were not authokized and
approved by the Compensation Committee or the Board of Directors.
162. Even assuming that the $97,392,654 had been properly authorized and approved, the
manner in which this sum was reflected in the Company's financial statements was glaringly false
and misleading, at least in part because the Company had neither incurred nor paid any Jjortion of
the above in connection with an offering. Moreover, it was not referred to in the offering dgcuments
which PwC was required to read (AU Section 711).
163. GAAS (AU Section 311) discusses the fact that audit involves developinplanning g
an overall strategy for the expected conduct and scope of the audit. It further states that:
The auditor should obtain a level of knowledge of the entity's business that willenable him to plan and perform his audit in accordance with generally acceptedauditing standards. That level of knowledge should enable him to obtain asunderstanding of the events, transactions, and practices that, in his judgment, mayhave a significant effect on the financial statements. . .Knowledge of the entity'sbusiness helps the auditor in:
a. Identifying areas that may need special consideration.
b. Assessing conditions under which accounting data are produced, processed,reviewed, and accumulated within the organization.
Evaluating the reasonableness of estimates.
d. Evaluating the reasonableness of management representations.
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C. Making judgments about the appropriateness of the accounting principlesapplied and the adequacy of disclosures.
164. PwC's purportedly complied with the requirement to develop an overJ11 GAAS
strategy for the expected conduct and scope of its audits as evidenced by a February 18, 2902 letter
(February 26, 2002 Form 8-K, Exhibit 99. 1) from Scalzo to John F. Fort, Chairman of TycI's Audit
Committee. It notes that PwC met with Fort and the other members of the Audit Cpmmittee
"periodically" to discuss PwC's worldwide audit approach and areas of audit focus for the purpose
of its overall annual audit of Tyco.
165. GAAS mandates (AU Section 230) that: "Due professional care is to be exercised in
Ithe planning and performance of the audit and the preparation of the report." Providing guidance
on the concept of due professional care, GAAS (AU Section 230) states:
Due professional care requires the auditor to exercise professional skeptici9.
Professional skepticism is an attitude that includes a questioning mind and a critic^I
assessment of audit evidence. The auditor uses the knowledge, skill, and ability
called for by the profession of public accounting to diligently perform, in good faith
and with integrity, the gathering and objective evaluation of evidence.
Gathering and objectively evaluating audit evidence requires the auditor to consider
the competency and sufficiency of the evidence. Since evidence is gathered ant
evaluated throughout the audit, professional skepticism should be exercised
throughout the audit process.
The auditor neither assumes that management is dishonest nor assumes unquestione1
honesty. In exercising professional skepticism, the auditor should not be satisfied
with less than persuasive evidence because of a belief that management is honest.:
166. During the performance of its audit procedures, PwC learned that the extra)rdinary
near-$ 100 million charge was cloaked as a component ofthe Tycom "Offering Expense," as an offset
to previously over-accruals of "General & Administrative Expenses," and as an adjustment to
accrued "Federal Income Tax." However, in contravention of GAAS, PwC did not gather and
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objectively evaluate any evidence (and certainly not any "persuasive evidence") in supp rt of the
propriety ofthe Company's accounting, and PwC did not question management's represen tion that
the bonus payments, particularly the huge bonus payment to Kozlowski, was not required to be
disclosed. A January 3, 2003 New York Times news article elaborated as follows:
Here's one interesting issue: The auditors, according to one person who has seen
documents from the audit, knew of a huge bonus payment to L. Dennis Kozlowski,
the former chairman and chief executive, that was not disclosed in the proxy, and
raised questions about it. But they accepted an oral assurance from a Tyco executi-e
that Tyco's lawyers had concluded the bonus payment did not need to be disclosed,
and did not tell either the board or the shareholders. The legal opinion in question did
not cover the facts of the situation, but the auditors did not ask to see it.
David Nestor, a spokesman for the auditing firm, declined to discuss specifics relate
to that bonus payment. But he did say: "We did not know that the disclosure w s
wrong. We raised questions about it, went to the company and were told that the
disclosure was appropriate."
167. The SEC, after its investigation of the issue, stated:
Scalzo first learned of the TyCom IPO bonuses in the course ofPwC's year-end aud4tin October 2000. An October 19 draft Discussion Outline from Scalzo's desk filets
bears a notation in his handwriting that states "IPO; GAIN -- offsets need memo"
and shows that Scalzo was aware of and focused on off-sets to the IPO. Scalzpsubsequently discussed the TyCom ]PO bonuses with Swartz, a primary beneficiary
of the bonuses, and was told that the bonuses were not material. Management also
represented to Scalzo that the bonuses were direct and incremental costs of the
TyCom IPO.
168. The foregoing illustrates PwC's flagrant violation ofGAAS (AU Section 333) which
states:
During an audit, management makes many representations to the auditor, both oraland written, in response to specific inquiries or through the financial statements. Such
representations from management are part of the evidential matter the independentauditor obtains, but they are not a substitute for the application of those auditingprocedures necessary to afford a reasonable basis for an opinion regarding thefinancial statements under audit.
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169. Pursuant to GAAS, PwC was required to perform audit procedures to cqrroborate
management's representation that Tyco's lawyers had concluded the bonus payment did not need
to be disclosed. PwC failed to comply with this GAAS.
170. Had PwC asked to see the legal opinion in question, it would have learnel that this
opinion did not cover the facts of the situation and that disclosure was required. In addition, had
PwC performed the necessary corroborative procedures it would have learned of the falsity of the
foregoing representations and called all other management representations into question. Ass GAAS
(AU Section 333) states:
If a representation made by management is contradicted by other audit evidence, the
auditor should investigate the circumstances and consider the reliability of the
representation made. Based on the circumstances, the auditor should consid r
whetherhis or her reliance on management's representations relating to other aspec s
of the financial statements is appropriate and justified.
171. Given the nature and magnitude of the audit issue (a huge non-disclosed bonus
payment to the chairman and chief executive), PwC should have significantly expanded the scope
of its audit and the nature of its procedures in observance of GAAS (AU Section 311) which states
that "conditions that may require extension or modification of audit tests" include "the existence of
related party transactions", and (AU Section 316) which states:
In performing procedures and gathering evidential matter, the auditor continually
maintains an attitude of professional skepticism. The performance of auditin
procedures during the audit may result in the detection ofconditions or circumstance 3
that should cause the auditor to consider whether material misstatements exist. If a
condition or circumstance differs adversely from the auditor's expectation, thIcauditor needs to consider the reason for such a difference.
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172. A September 30, 2002 article in The Wall Street Journal quoted Lynn Turner, a
former chief accountant at the Securities and Exchange Commission as stating the follo 4'ing with
regard to the non-approved, non-disclosed and improperly recorded bonuses: "this is calldd fraud."
173. An October 14, 2002 article in Business Week entitled "Is The Avalanche Headed
for Pricewaterhouse? Investigators Are Digging Into The Firm's Tyco Dealings" states:
...Especially outrageous to such critics as former SEC Chief Accountant Lynn
Turner is PwC's failure to flag nearly $100 million in forgiven executive loans tht
Tyco booked against the gain from the partial initial public offering of a subsidiaily
in 2000. "Auditors must look at these large adjustments, because that is where we
find the fraud has always been committed," says Turner.
But PwC's relationship with Tyco went far beyond auditing the company's book.
Reducing its tax bill has long been a key Tyco strategy for boosting earnings, anI
PwC was deeply involved in that effort. According to its 2001 proxy statement, 1f
addition to $13 million PwC earned in 2001 for auditing Tyco, the firm was pail
even more--$18 million--for tax work. For that hefty fee, a Tyco spokesman say
PwC helped Tyco with its "U. S. tax planning, and the review and preparation ofnor^-
U. S. tax returns in more than 80 countries." In addition, Tyco says, "PwC reviews the
Tyco tax department's analysis of our tax rate every quarter."
What tax work PwC was doing and how that affected its audits is of particular
interest because Tyco has been based in the tax haven of Bermuda since 1997. It als^
has dozens of subsidiaries in other offshore tax havens. These moves saved th
company hundreds of millions in U.S. taxes, providing it a major competitive
advantage. Tyco says this structure saved the company $600 million in taxes in 200
alone.
Although it is common practice among accounting firms to serve as both auditor and
tax adviser, the dual role has given rise to a chorus of critics. And for PwC, wearing
both hats at scandal-ridden Tyco risks at least an appearance of conflict of interest.
That could further complicate life for PwC and its CEO, Samuel A. Di-Piazza Jri,Critics of the practice argue that tax work often involves helping companies take
advantage of legal stratagems to cut their tax bills. A company must then estimate its
tax bill and set up reserves to pay its taxes. A company that is sure its estimated tax
savings would come through might reserve very little against the unlikely chance the
savings would not occur. The accuracy of those estimated savings and reserves are
then reviewed by the auditor, which in Tyco's case was the same firm, PwC. "Youare auditing the validity of a product that you're selling," complains John L. Buckley,
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Democratic counsel to the House Ways & Means Committee. "It is a gross conflil tof interest."
174. On or about August 25, 1999 , Belnick completed a Tyco disclosure form f?r PwC in
connection with its annual audit of Tyco's financial statements . In that form, Belnick confirmed the
balance of his outstanding New York relocation loan.
175. Thereafter , Belnick regularly completed disclosure forms for PwC confi ing the
balance of his outstanding New York relocation loan and , subsequently, his Utah relocation loans.
On two occasions , Belnick advised PwC that he actually owed more on the relocation loans,than they
calculated.
176. For example, on October 17, 2001, Belnick confirmed the Utah (and reconfirmed the
New York) relocation loan to PwC . In this confirmation reply, Belnick corrected the
balance of the New York loan by indicating that the balance he owed was in fact $225,0Q0 higher
than the balance listed on the form.
177. Similarly, Kozlowski and Swartz, regularly disclosed loans from the Corppany in
response to PwC confirmation requests.
178. Each of the Belnick loans was evidenced by a promissory note which was openly
available to PwC for inspection and audit. For example, the following notes which were made,
executed and delivered to Tyco by Belnick were readily available to PwC:
Date Dollar Amount Interest Rate
September 4, 1998 275,000.00 Long term annual
rate under IRC
Section 1274(d)November 6, 1998 2,610,000.00 0%January 19, 1999 120,000.00 0%March 16, 1999 200,000.00 0%
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April 13, 1999 60,000.00 0%May 5, 1999 250,000.00 0%June 18, 1999 141,000.00 0%July 13, 1999 106,000.00 0%August 5, 1999 200,000.00 0%August 25, 1999 105,000.00 0%October 14, 1999 150,000.00 0%February 16, 2000 75,000.00 0%July 12, 2000 50,000.00 0%August 21, 2000 50,000.00 0%April 6, 2001 50,000.00 0%May 22, 2001 50,000.00 0%September 4, 2001 10,056,767.84 0%October 30, 2001 240,370.85 0%December 3, 2001 46,359.09 0%January 3, 2002 14,843.08 0%January 28, 2002 10,000.00 0%March 13, 2002 50,258.49 0%
$ 14,910,599.35
179. Each of the loans to Kozlowski and Swartz was similarly evidenced by a promissory
note which was openly available to PwC for inspection and audit.
180. Accordingly, there is no question that PwC knew of the loans and kept track of the
balances owed. However, in violation of GAAS, PwC failed to:
a. Obtain evidence regarding the existence, fair value, and transfer bility of
collateral as well as rights to the collateral . (AU Section 332)
b. Inspect or confirm and obtain satisfaction concerning the transferability and
value of collateral . (AU Section 333)
c. Apply the procedures necessary to obtain satisfaction concerning the purpose,
nature, and extent of these loan transactions and their effect on the financial statemeWis. "The
procedures should be directed toward obtaining and evaluating sufficient competent evidential matter
and should extend beyond inquiry of management ." (AU Section 334)
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viii. PwC Ignored The Improper $20 Million Finder's Fee
Paid To Walsh In Connection With The CIT Acquisition
181. In early 2001, Walsh recommended to the Board that Tyco acquire a financiall services
company, and later proposed that he introduce Kozlowski to the Chairman and CEO ofl The CIT
Group, Inc. ("CIT") a large financial services company. Subsequent negotiations led to an
for Tyco to acquire CIT, which closed in June 2001.
182. After the terms ofthe CIT transaction had been agreed upon, Kozlowski caused Tyco
to pay to and for the benefit of Walsh a $20 million fee for his role in the transaction "the $20
million Walsh payment").
183. Tyco filed a civil complaint in the United States District Court for the outhem
District ofNew York against Walsh, alleging breach offiduciary duty, inducing breaches of fiduciary
duty, and related wrongful conduct involving the $20 million Walsh payment.
184. On December 17, 2002, Walsh pleaded guilty to a felony violation ofNew Fork law
in the Supreme Court of the State of New York (New York County) and settled a civil aiction for
violation of federal securities laws brought by the Securities and Exchange Commissi6n in the
United States District Court for the Southern District ofNew York. Both the felony charge and the
civil action were brought against Walsh based on the $20 million payment purportedly made for
Walsh 's assistance in arranging the acquisition of CIT.
185. The felony charge accused Walsh ofintentionally concealing information coficerning
the payment from Tyco's directors and shareholders while engaged in the sale of Tyco securities in
the State of New York. The SEC action alleged that Walsh knew that the registration statement
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covering the sale of Tyco securities as part of the CIT acquisition contained a
misrepresentation concerning fees payable in connection with the acquisition.
186. Pursuant to the plea, Walsh agreed to pay $20 million in restitution to
material
and to
pay other fines to the State of New York. Pursuant to the settlement , Walsh consented to an order
permanently enjoining him from violating provisions of the federal securities laws, requ}ring him
to pay restitution to Tyco and permanently barring him from serving as an officer or director of a
publicly held company.
187. Tyco received Walsh's restitution payment of $20 million on December ll , 2002.
188. The above referenced February 18, 2002 letter (February 26, 2002 Form 8- ; Exhibit
99.1) from Scalzo to Fort states:
One of the areas of our audit focus on Tyco relates to business combinations. Tl1e
nature ofthe procedures that we perform related to any specific business combinatioi
is dependent on the nature and materiality of the transaction. Each significant
business combination may have unique characteristics, and accordingly we exercis
independent judgment as to what audit procedures related to any specific businesscombination are necessary to support our audit opinion on the financial statements
of Tyco taken as a whole. I
A business combination work plan to achieve the audit objectives in conjunction witiour overall audit would likely include some combination ofthe following procedures,
depending on individual facts and circumstances:
- Evaluate the Company's overall application of purchase accountinl
(consideration minus fairvalue ofassets acquired and liabilities assumed pluu
purchase accounting liabilities = excess purchase price)
- Obtain the Company's analysis ofconsideration with respect to the exchangeof shares and stock options/restricted stock
- Review the associated deal costs
- Read the acquisition agreement
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- Meet the acquired company's auditors and review the acquired company's
audit work papers (our procedures with respect to the acquired compa y
would not be designed to provide any assurance on the acquired company's
financial statements)
In connection with the acquired company's results for the period subsequel t
to the last published financial statements through the acquisition
consummation date (pre-acquisition period):
Obtain detailed explanations for unusual trends
Discuss with acquired company management and prior auditors basis for arty
unusual charges
- Perform audit procedures on opening balance sheet of significant acquisitions
- Assess the fair value adjustments recorded by the Company (inventory, A/ ,
environmental, legal, other long-term commitments, etc.) to the opening
balance sheet
- Evaluate the Company's allocation of purchase price to assets (both tangibke
and intangible) and liabilities
Obtain and read any external valuations relied upon by the Company ii
allocating purchase price
- Evaluate the purchase accounting liabilities recorded by Tyco, if an ,
including integration plans, severance agreements, facility consolidations, and
other long-term obligations (leases)
- Consider any subsequent adjustments recorded by the Company to fair valub
adjustments or purchase accounting liabilities
Evaluate any adjustments recorded by Tyco related to contingerit
consideration (earn outs or purchase price adjustments)
Evaluate the audit evidence related to the Company's subsequent spending
for the purchase accounting liabilities on a quarterly basis
Read any registration statements and related disclosure with respect to the
acquisition (Form S-4, prospectus/proxy statement)
Inquire as to pro forma disclosures , if required for Tyco' s SEC filings
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.IObtain the significant subsidiary test prepared by the Company to determ47eifacquired company financial statements are required to be filed as part oftheregistration statement
Consent to our audit opinion as part of any registration statement
189. Having performed procedures such as these in connection with its audits pf Tyco's
financial statements, PwC knew and disregarded the fact that Walsh received an improper $20
million payment; that $20 million of the total $22.3 million CIT "acquisition related costs" which
were reported in the Company's financial statements were paid to or for the benefit o'Walsh.
190. The staggering magnitude ofthe portion ofthe "acquisition related costs" wlpich were
paid to or for the benefit of Walsh rendered the $20 million Walsh payment impossible to overlook
during the "review" of "the associated deal costs" as noted in the February 18, 2002 letter from
Scaizo to Fort.
191. The SEC, after investigating the issue , reported the following (SEC Accour ting And
Auditing Enforcement Release No. 1839):
...in early December 2001, during the financial statement audit for Tyco's fiscal ye4lr2001, Scalzo was informed by the PwC team auditing Tyco's Tyco Capitol
Corporation subsidiary that the team had noticed a $20 million finder's fee paid tp
Frank E. Walsh , Jr., then a Tyco outside Director , in connection with Tyco ' s 20011
acquisition of The CIT Group , Inc. (Tyco Capital Corporation , later renamed CIT
Group Inc ., was formed as a result of Tyco's acquisition ofThe CIT Group, Inc.) Thp
Tyco Capital Corporation audit team especially wanted Scalzo to know that the $20million fee consisted of a $10 million payment directly to Walsh and a $10 millio^contribution by Tyco to a charitable foundation chosen by Walsh . By the time thalt
the Tyco Capital Corporation audit team informed Scalzo about the finder ' s fee, thePwC audit team under Scalzo had already interviewed Tyco management regarding
the existence of related party transactions for Tyco 's fiscal year 2001 and had been
told that there were no such transactions to report. Therefore , Tyco management hadgiven the audit team false information. Once again , Scalzo was faced with facts thatraised serious questions about the integrity of Tyco management... during the fiscalyear 2001 audit, Scalzo learned that Tyco management had not voluntarily informedthe PwC audit team about the Walsh CIT finder's fee , and in fact had told the audit
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team that there were no related party transactions to report for that fiscal year. A.)
another PwC audit team found, and informed Scaizo of, thefee, Scalzo discus.it with Tyco management and was told that thefee was not materialfor purpoofseparatefinancial statement disclosure. Although his client hadgiven the at,team false information regarding related party transactions, Scalzo did ,reevaluate audit risk for such transactions. Accordingly, he did not perform,directPwCpersonnel toperform, any additional audit steps . Moreover, without
benefit ofany such additional steps, Scalzo reached a determination that the paym
was not material for purposes of separate financial statement disclosure. Scalzo
not inform the audit committee about the fee.
192. PwC identified and recklessly failed to investigate the extremely questionablei
transaction which was material in amount and made audit judgements that no reasonable auditor
would have made if confronted with the same facts.
193. Even assuming that PwC did not know that the $20 million Walsh payrhent was
improper, PwC knew and disregarded or was reckless in not knowing that the payment wasl required
to be disclosed in the Company's financial statements (FASB Statement No. 57), and that such
disclosure was not provided . Accordingly, PwC was required to express a qualified opinion (AU
Section 50 8) and to disclose the facts surrounding the $20 million Walsh payment.
194. PwC violated GAAS by failing to express a qualified opinion on the fiscal 2001
financial statements of the Company, when these financial statements concealed the material facts
surrounding the $20 million Walsh payment and set forth the following materially false and
misleading disclosure (September 30, 2001 Form 10-K; Note 2):
CIT was purchased for $9,455.5 million, consisting of. the issuance ofapproximatell'
133.0 million Tyco common shares, valued at $6,650.5 million, for approximately
73% ofthe outstanding shares ofCIT; a cash payment of $2,486.4 million to Dai-IchKangyo Bank, Limited for the purchase of approximately 27% of the outstandingshares of CIT; and options assumed valued at $318.6 million. The $9,455.5 millionpurchase price plus $29.2 million in acquisition related costs incurred by TycoIndustrial have been reflected on Tyco Capital's Consolidated Balance Sheet as acontribution by Tyco, in accordance with "push-down" accounting for businesscombinations. In addition, $22.3 million was paid by Tyco Industrial for
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acquisition related costs and have been reflected on Tyco Capital's ConsolidatedBalance Sheet as an additional capital contribution . [emphasis added]
195. PwC knew and ignored the fact that the above disclosure was materially
misleading.
196. GAAS (AU Section 325) provides guidance in identifying and reporting
false and
that relate to a company's internal control. It requires the auditor to report certain criticl matters
to the Audit Committee. These critical matters are referred to as "reportable conditions[' and are
defined as issues relating to significant deficiencies in the design or operation ofthe internil control
that could adversely affect the organization's ability to record, process, summarize, aid report
financial data consistent with the assertions of management in the financial statements.
197. Significantly , GAAS (AU Section 325) notes that "evidence of signil scant or
extensive undisclosed related party transactions" is among the "examples of matters ' hat may
constitute a reportable condition.
198. PwC violated GAAS in not issuing "reportable condition" letters to Tyc 's Audit
Committee regarding the $20 million Walsh payment and the other related party transactions
described above.
199. As stated in a September 12, 2002 press release issued by the SEC:
...Kozlowski and Swartz granted themselves hundreds ofmillions ofdollars in secrelt
low interest and interest-free loans from the company that they used for personall
expenses . They later caused Tyco to forgive tens of millions of dollars they owed thecompany, again without disclosure to investors as required by the federal securities
laws. Belnick, according to the complaint , failed to disclose that he received more
than S 14 million in interest-free loans from the company to acquire two residencesin New York City and Park City, Utah.
"Messrs. Kozlowski, Swartz and Belnick treated Tyco as their private bank, taking
out hundreds of millions of dollars of loans and compensation without ever telling
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investors," said Stephen M. Cutler, the SEC's Director ofEnforcement. "DefendanIs
put their own interests above those of Tyco's shareholders. Those shareholder sdeserved better than to be betrayed by the management ofthe company they owned"
200. But forPwC's recklessness , theundisclosed "private bank" never would have existed.
201. GAAS (AU Section 325) lists the following deficiencies, certain of wI ich were
present at the Company during the period of PwC's retention as independent auditor, among
"examples of matters that may be reportable conditions":
Deficiencies In Internal Structure Design
o Inadequate overall internal control structure design.
o Absence of appropriate segregation of duties consistent with appropriate
control objectives.
o Absence of appropriate reviews and approvals of transactions, accounting
entries, or systems output.
o Inadequate procedures for appropriately assessing and applying accounting
principles.ii
o Inadequate provision for the safeguarding of assets.
o Absence of other control techniques considered appropriate for the type an1l
level of transaction activity.
o Evidence that a system fails to provide complete and accurate output that i^consistent with objectives and current needs because of design flaws.
Failures In The Operation Of The Internal Control Structure
o Evidence of failure of identified controls in preventing or detecting
misstatements of accounting information.
o Evidence that a system fails to provide complete and accurate outputconsistent with the entity's control objectives because of the misapplicationof control procedures.
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o Evidence of failure to safeguard assets from loss, damage or
misappropriation.
o Evidence of intentional override of the internal control structure by those in
authority to the detriment of the overall control objectives of the system.
o Evidence of failure to perform tasks that are part of the internal control
structure, such as reconciliations not prepared or not timely prepared.
o Evidence of willful wrongdoing by employees or management.
o Evidence of manipulation, falsification, or alteration of accounting records
or supporting documents.
o Evidence of intentional misapplication of accounting principles.
o Evidence of misrepresentation by client personnel to the auditor.
o Evidence that employees or management lack the qualifications and traininig
to fulfill their assigned functions.
Other '
o Absence of a sufficient level of control consciousness within thk
organization.
o Failure to follow up and correct previously identified internal control
structure deficiencies.
o Evidence of significant or extensive undisclosed related party transactions}
o Evidence of undue bias or lack of objectivity by those responsible fok
accounting decisions.
202. PwC identified (through its review of Tyco disclosure forms which confirmed the
improper interest-free loans and various other audit procedures particularized above) and'' ignored
evidence of significant and extensive undisclosed related party transactions, and the existence of
material weaknesses in the Company's system of internal control which enabled these undisclosed
related party transactions to be concealed. In addition, as described herein, PwC identified the
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complete breakdown of established internal control systems which were required to ave been
operating effectively in order to safeguard the Company's assets. PwC knowingly or ecklessly
failed to inform the Company's Audit Committee of these facts and thus permitted Kozlowski,
Swartz and Belnick to treat Tyco as their private bank.
203. For example, logs were maintained as to who used the Company-owned or leased
aircraft and when they were used. However, there was inadequate documentation ofthe pu oses for
which the aircraft was used. This material internal control deficiency opened the floo gates to
unauthorized personal use. Similarly, certain employees had company cars and also received car
allowances for company use of their personal cars.
204. In addition to the fact that unauthorized contributions were made to charities as
particularized above, no one was responsible for verifying that the charity existed and w s a valid
tax-exempt organization. In this regard, an unauthorized "contribution" in the sum of $150,000 was
made to a recipient that did not qualify as a charity.
205. The magnitude of the amounts involved in the fleecing of Tyco were so huge that it
could not possibly have gone unnoticed by an auditor. The number of unusual, high dollar, journal
entries that were required to conceal this fleecing and the number of general ledger ccounts
impacted by these journal entries made it virtually impossible to audit the company's financial
statements without noticing the systematic and relentless fraud.
ix. PwC Ignored The False Recording Of RevenueWith Regard To ADT And Other Companies
206. Tyco's financial statements were also materially impacted by the false recordation
of revenues and profits. For example:
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a. Certain intra-company and inter-company EarthTech revenues were not
eliminated in consolidation, resulting in a $41 million overstatement ofrevenues for fiscal 'ear 2001
and a $101 million overstatement of revenues through the first three quarters of fiscal yelIar 2002,
b. Fees charged to dealers in the Company's ADT segment when service
contracts were purchased were recorded as a reimbursement ofSG&A expenses when such trees were
in excess of reimbursable costs incurred and should be deferred and amortized over the ¶stimated
useful life of an acquired customer relationship. This improper accounting treatment resulted in a
massive overstatement of revenue as discussed above.
iOperating expenses in connection with the upgrade ofADT' s subscriber assets
were improperly capitalized, resulting in a material overstatement of recorded pre-tax eanings.
207. This false recordation of revenues and profits was not in conformity with ^AAP as
summarized in SEC Staff Accounting Bulletin No. 101, Accounting Principles Board,("APB")
Opinion No. 10, Accounting Research Bulletin ("ARB") No. 43, FASB Statements of Financial
Accounting Concepts, and SEC Accounting And Auditing Enforcement Release No. 812 (S!ptember
5, 1996) which states:
Generally Accepted Accounting Principles ("GAAP") provide that revenue should
not be recognized until an exchange has occurred, the earnings process is completd,
and the collection of the sales price is reasonably assured.
208. As admitted by the Company in its December 30, 2002 Form 8-K: "there was both
a notable lack of documentation supporting the establishment and utilization of reserves and a
pattern of aggressive purchase accounting..." which improperly and in contravention of GAAP
(FASB Statement No. 38, FASB Statement No. 5, EITF 94-3, EITF 95-3, andAPB Opinion No. 16)
included:
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a. Reductions in the book value of acquired assets (i.e. reserves forlaccounts
receivable, inventories, and fixed asset write downs).
b. Virtually no allocations to increase tangible depreciable assets (rafely were
inventory or fixed assets stepped up in value).
c. Additions to existing reserves previously recorded by the acquirod entity,
including significant reserves recorded for matters not previously reserved by the acquiijed entity
(e.g. warranty and environmental reserves) accruals).
d. Reserves for exit costs that did not qualify as exit costs.
e. Expansive and liberal recordation of pre-acquisition contingencies for
litigation and other accruals.
209. The nature and impact of these non-documented and improper item4 on the
Company's pre-tax earnings , as described in its December 30, 2002 Form 8-K, may be reflected as
follows:
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Prior to
IssueFiscal
2000
Fiscal
2000
Fiscal
2001 Total($ In Millions)
Options valuation 0.0 0.0 5.6 5.6
Retention bonuses 1.5 0.0 0.0 1.5
IT implementation & other 1.7 0.0 0.0 1.7
Inventory valuations 13.3 21.0 (26.2) 8.1Litigation settlement 0.0 1.0 0.0 1.0
Non-exit salary reserves 2.3 0.0 0.0 2.3
Tariff reserve reversals 0.0 0.0 5.4 5.4
Accrual for unfavorabletransition services agreements 3.9 0.0 0.0 3.9
Excess accrual for salesand use tax 0.0 4.4 0.0 .4
Excess fringe benefit accrual 0.0 0.0 0.6 .6
Supply contract reserve 0.0 0.0 1.6 1.6
Total Pre-tax entries $22.7 $26.4 $13.0) $3T1
X. PwC Ignored Reversals of "Cookie Jar" Reserves
210. In addition , over the period 1997-2001, no less than $41.4 million 'of other
unsupported cookiej ar reserves were reversed to income. As stated by the Company in its
30, 2002 Form 8-K, "such reversals were timed on a number ofoccasions for the purpose ofmaking
EBIT targets."
211. A "cookie jar" reserve, as explained in the SEC's Accounting and Auditing
Enforcement Release No. 1393 (May 15, 2001, In the Matter of Sunbeam Corporation): ` refers to
inflated or wholly improper reserves posted to provide a cushion against earnings shortfalls in later
periods, when those reserves can be drawn into income."
212. The SEC investigated this issue and concluded (SEC Accounting And Auditing
Enforcement Release No. 1839):
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As noted above, during the course of the audit of Tyco's financial statements forfiscal year ended September 30, 1998, the PwC audit team noticed a seriestransactions from July 1998 in which Kozlowski, Swartz, and one additional T3executive exercised Tyco stock options, by borrowing from the KELP, and then sithe shares realized from their options exercises back to the company the ni
business day, along with additional shares previously held by the executives, throu
an off-shore Tyco subsidiary. Tyco then wrote a check to the executives, representi
a net settlement of the stock buybacks, the KELP loans used to exercise the optio
interest on those loans, and other unrelated KELP loans owed by the executiv
After consulting with PwC national partners, the PwC audit team came to
conclusion that Tyco should include a compensation charge of approximately $
million.
On October 15, 1998, when PwC first learned of the transactions, Tyco was within
days of a scheduled October 22 earnings release and had already conditioned Wa 1
Street analysts to expect earning numbers that did not include the previous l y
unanticipated compensation charge . Taking an additional multi-million dollar
compensation charge would have caused the company to report earnings per sha e
that would have been several cents lower than those the Street was anticipating.
Scalzo clearly knew the urgency of this issue at the time that he consulted wit1h
PwC's national partners . A Scalzo e-mail communication summarized the accountin g
issue for his partners and concluded by stating , "The potential impact to Tyco on thiis
issue is significant."
Faced with the reality ofhaving to book an unanticipated $40 million compensation
charge, Tyco suddenly arrived at $40 million in additional, contemporaneous,
post -period adjustments which had the effect of negating the impact of the $40
million charge . The entries are set forth in a memorandum dated October 20, 199 ,
from Tyco ' s corporate controller at the time . The Tyco entries negating the impa t
of the compensation charge were a series of credits to the selling , general anSI
administrative expenses ("SG&A") line item on Tyco's income statement. The $4Q
million in credits raise significant issues -- each of which provided additional notice
to Scalzo about the integrity of Tyco ' s management . Of those credits, $ 7.8 million
resulted from Tyco reversing a previous "fourth quarter charge for restricted stock
expense for certain executives no longer required ." The rationale advanced for that
reversal was that the executives had decided to forego the corresponding bonuses in
the fourth quarter.
One issue raised by the credits was the fact that $12.25 million of them resulted fromTyco's reversal of an "accrued restructuring reserve" into SG&A. That decrease ofSG&A was accomplished by first reversing the accrued restructuring reserve againstrestructuring expense on the restructuring ledger and then debiting restructuringexpense and crediting administrative expense on Tyco's general ledger. Scalzo was
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aware ofthe nature ofthese adjustments at the time they were made. Documents
in Scalzo's handwriting show that Scalzo was also aware of an additional iss e
raised by the reversal of the restructuring reserve -- the fact that Tyco hadsuddenly decided that $12.25 million of the reserve would be reversed. Scalzo's
notes made at the time that Tyco was attempting to resolve these issues contain a
notation -- with the letters "SEC" printed to its left -- stating, "Why is this the rig1t
qtr to reverse restructuring vs prior periods." The Tyco controller's memorandum
lists the justification for the reversal as the need "[t]o reverse certain restructuri g
items that have been resolved during the fourth quarter." Scalzo accepted this writttn
representation from his client.
Of the remaining credits, several were the result of entries that PwC previously had
advised Tyco to make, but which Tyco in the past had declined. Tyco, at least in pal1t,
followed previously rejected PwC recommendations in recording $19.2 million 9 f
the adjustments. Faced with a $40 million post-period crisis, however, Tyco changed
its mind and made the previously rejected entries on its books. Any doubt as o
whether Tyco would have taken these entries otherwise should be put to rest by t e
fact that Tyco was days away from its earnings release and had already condition d
analysts to expect earnings that did not include the impact of any these entries.
Part of the $19.2 million in adjustments was a $2 million credit resulting from Tyco i s
partial reversal of its "corporate general reserve." In fact, during the previous fisc!l
year, PwC had noted on its Summary of Unadjusted Differences ("SUD") that th^e
reserve was per se impermissible and should be reversed completely. At that tim^,
Tyco had declined to reverse the reserve in any amount, and, at the time of the
post-period adjustments off-setting the impact of the $40 million compensation
charge, Tyco only reversed $2 million of that reserve -- leaving the remainder ofthe
accrual available for future use.
The facts point to Scalzo's knowledge of the process whereby Tyco arrived at $40
million in adjustments to negate the impact of the compensation charge. The note'
in Scalzo's handwriting, which make sense only ifthey date from some point in time
prior to the final "resolution" of the matter, set forth, near the bottom of one page,
three line items reading, "13M reverse restricted stock award; 14M reverse PC hi
13M restructuring reversal." The line items aggregate $40 million. Moreover, the
closely resemble the types ofpost-period adjustments that eventually were made ofi
Tyco's books. All of these issues provided further notice to Scalzo regarding the
integrity of Tyco's management. Moreover, the very next fiscal year the post-close
fire-drill reoccurred.
During the annual audit for Tyco's fiscal year ended September 30, 1999, the PwC
team auditing Tyco's Flow Control division came to the conclusion that $10.6
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million in expenses at the division's Earth Tech subsidiary had been imprope lycharged against purchase accounting accruals. Scalzo, once informed ofthe findings,told the client that these errors were "black and white" and had to be reversed.
Tyco, in fact, agreed to reverse the entries and allow the expenses to flow throu^h
Tyco's operating expense. By memorandum dated October 21, 1999, the Flow
Control divisional controller informed the Tyco corporate controller that "[p]er our
discussion, Tyco Flow Control will reverse $10.6 in of inappropriate Earth Te h
purchase accounting spending" and that "Flow Control will reverse the following
accruals to cover this inappropriate purchase accounting spending." (emphasis adde$1)
The memorandum then listed three items, aggregating $10.6 million:
$2.1 in - Dog Leg Accruals (excess booked in post close in Boca)
$5.4 in - Flow Control Books (Account 021-0035)
$3.1 m - Corporate (Boca) General Reservei
Once again, suddenly faced with an unexpected charge, Tyco came up wi
additional post-period adjustments to off-set the impact of the unanticipated charg .
In fact, the adjustments that "cover" the purchase accounting reversals were all items
that had been slated by PwC for inclusion on the fiscal year 1999 SUD, although
Tyco booked them selectively and only partially, as necessary to off-set the impact
of the unexpected charges. The Flow Control memorandum leaves little doubt th t
Tyco would have declined to make the adjustments, barring the unanticipated
post-period $10.6 million in additional expense. In fact, the $3.1 million revers?l
from the corporate general reserve is a reversal ofthe same corporate reserve utilized
a year earlier when Tyco covered the effect of the $40 million compensation charge.
Again, the very existence of that reserve had been noted on the PwC SUD annually,
and annually Tyco had declined to reverse the accrual. The $2.1 million reversal CIf
the excess "Dog Leg" accrual, moreover, bears no economic or business relation to
the 1996 Earth Tech acquisition. "Dog Leg" was the Tyco transactional code namie
for its August 1999 disposition ofThe Mueller Company, another subsidiary withinthe Flow Control division.
Scalzo continued to witness Tyco 's use ofgeneral unallocated reserves to off-setunexpected expenses throughout Tyco'sfiscalyears 1998-2001. For example, the
PwC Discussion Outline for the Tyco fiscal quarter ended June 30, 2001, notes
"[g]eneral reserves of$26m recorded through post-close entries; Increase is allocated
to various Corporate accrual and reserve accounts, but intention is primarily to off-setpossible (but unidentified) under accruals at a divisional level."
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213. The above referenced February 18, 2002 letter from Scalzo to Fort states that PwC
evaluated "the audit evidence related to the Company' s subsequent spending for the purchase
accounting liabilities on a quarterly basis." Accordingly, PwC was fully aware of the [act that
cookiejar reserves were improperly established and, then, later strategically reversed o inflate
income.
214. GAAS (AU Section 329) "requires the use of analytical procedures in the planning
and overall review stages of all audits ." Analytical procedures involve comparisons of Irrecorded
amounts , or ratios developed from recorded amounts, to expectations developed by the auditor. They
include (AU Section 329) a review of:
a. Financial information for comparable prior period(s) giving considgration to
known changes.
b. Anticipated results - for example, budgets, or forecasts including
extrapolations from interim or annual data.
c. Relationships among elements of financial information within the eriod.
d. Information regarding the industry in which the client operates - for example,
gross margin information.
e. Relationships of financial information with relevant nonfinancial information,
215. Even assuming that PwC failed to "audit evidence related to the Company's
subsequent spending for the purchase accounting liabilities on a quarterly basis" as represented in
the February 18, 2002 letter from Scalzo to Fort, the proper performance of GAAS-mandated
analytical procedures would have revealed (as ultimately disclosed in a Form 8-K which the
Company filed with the SEC on December 30, 2002) the foregoing to PwC.
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216. For example, late in 2002, a review was undertaken of all of the Company's
individual adjusting journal entries of $10 million or more in size, or all contemporaneous multiple
like-kind adjustments that aggregated to $10 million or more in size, taken at Tyco's corporate level
between fiscal years 1999 and 2002 within 15 days before and after the books were closed. Based
upon this review, it was determined that (December 30, 2002 Form 8-K):
For certain categories, the contemporaneous documentation available often does n t
provide (i) an adequate description of the entry; (ii) the identification of the Tyco
employee who requested or initiated the entry; (iii) the identification of the Tyco
employee who prepared the adjustment; and (iv) written approval by management.
Written procedures or standard forms for use in the consolidation process do nct
appear to exist.
217. As stated above, GAAS (AU Sections 316, 329 and 334) required PwC to review
accounting records for large, unusual, or nonrecurring transactions or balances, paying
attention to transactions recognized at or near the end of the reporting period.
218. It is, therefore , inconceivable that PwC could have audited the Company's
statements in compliance with GAAS without having identified the fact that the largest journal
entries were anonymous, unapproved, and inadequately documented.
219. PwC either identified and ignored , or recklessly failed to investigate ektremely
questionable high-dollarjournal entries, and made audit judgments that no reasonable auditor would
have made if confronted with the same facts . Accordingly, PwC audits were so deficient tthat they
amounted to no audit at all.
220. GAAS (AU Section 316) states that the following are examples ofrisk factor. relating
to misstatements arising from fraudulent financial reporting:
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a. Asignificantportionofmanagement'scompensationrepresentedbybonuses,
stock options, or other incentives, the value of which is contingent upon the entity achieviitg unduly
aggressive targets for operating results, financial position, or cash flow.
b. An excessive interest by management in maintaining or increasing tle entity's
stock price or earnings trend through the use of unusually aggressive accounting practic^s.
c. Domination of management by a single person or small grow ' without
compensating controls such as effective oversight by the board of directors or audit committee.
d. Inadequate monitoring of significant controls.
e. Management failing to correct known reportable conditions on a timely basis.
f. Management setting unduly aggressive financial targets and expectations for
operating personnel.
g. Management displaying a significant disregard for regulatory authorities.
h. Assets, liabilities, revenues, or expenses based on significant estimates that
involve unusually subjective judgments or uncertainties, or that are subject to potential significant
change in the near term in a manner that may have a financially disruptive effect on the entity - such
as ultimate collectibility of receivables, timing of revenue recognition, realizability of Inancial
instruments based on the highly subjective valuation of collateral or difficult-to assess repayment
sources, or significant deferral of costs.
Significant related-party transactions not in the ordinary course of business
or with related entities not audited or audited by another firm.
j. Significant, unusual , or highly complex transactions , especially those close
to year end, that pose difficult "substance over form" questions.
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221. Each ofthese risk factors was glaringly present during the PwC's audits. PwC failed
to recognize that the presence of these risk factors indicated (AU Section 316) "a need to modify
procedures," a need to exhibit an "increased sensitivity in the selection of the nature andl extent of
documentation to be examined in support ofmaterial transactions, and an "increased recognition of
the need to corroborate management explanations or representations concerning material matters."
222. Tyco held annual shareholders' meetings at which a representative of ?wC was
present and was afforded an opportunity to make a statement regarding the Company's
practices and to answer questions that maybe asked by stockholders. At these annual shareholders'
meetings, said PwC representative failed to disclose the fact that the Company's financial
were not prepared in conformity with GAAP, or that the Company was in violation of SEC rules
which require (i) a reporting company to devise and maintain a system of internal
controls sufficient to reasonably assure, among other things, that transactions are recprded as
necessary to permit preparation of financial statements in conformity with GAAP, and SVC rules
which require (ii) a reporting company to make and keep books, records, and accounts, which in
reasonable detail, accurately and fairly reflect the transactions of the company. Further, said PwC
representative failed to disclose, to the stockholders, the fact that Kozlowski, Swartz and Belnick
treated Tyco as their private bank, surreptitiously taking out hundreds ofmillions of dollar' of loans
and compensation.
223. PwC assisted Kozlowski , Swartz , Belnick and Walsh in concealing thir illicit
activities in order to retain a client that remitted tens of millions of dollars of fees to PwC each year.
For this same reason, when Breen and FitzPatrick took charge of the Company, PwC also. assisted
them in concealing certain of Tyco's past and continuing accounting frauds.
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VIII . APPLICABILITY OF PRESUMPTION OF RELIANCE:FRAUD-ON-THE-MARKET DOCTRINE
224. At all relevant times , the market for Tyco's securities was an efficient marlet for the
following reasons, among others:
a. Tyco's common stock met the requirements for listing, and was ^isted and
actively traded on the NYSE a highly efficient and automated market;
b. As a regulated issuer, Tyco filed periodic public reports with the SEC and the
NYSE;
Tyco regularly communicated with public investors via established market
communication mechanisms, including through regular disseminations of press releasos on the
national circuits ofmajornewswire services and through other wide-ranging public disclosures, such
as communications with the financial press and other similar reporting services; and
d. Tyco was followed by several securities analysts, posted on Tyco's Iweb site,
employed by major brokerage firms who wrote reports, which were distributed to the sales force and
Icertain customers of their respective brokerage firms. Each of these reports was publicly available
and entered the public marketplace.
225. As a result of the foregoing, the market for Tyco's securities promptly digested
current information regarding Tyco from all publicly available sources and reflected such^I
information in Tyco's stock price. Under these circumstances, all purchasers of Tyco's securities
during the Class Period suffered similar injury through their purchase of Tyco's securities at
artificially inflated prices and a presumption of reliance applies.
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XI. NO SAFE HARBOR
226. The statutory safe harbor provided for forward-looking statements undor certain
circumstances does not apply to any of the allegedly false statements pleaded in this
Many ofthe specific statements pleaded herein were not identified as "forward-looking stajtements"
when made. To the extent there were any forward-looking statements, there were no
cautionary statements identifying important factors that could cause actual results to differ
from those in the purportedly forward-looking statements. Alternatively, to the extenti that the
statutory safe harbor does apply to any forward-looking statements pleaded herein, Defen4ants are
liable for those false forward-looking statements because at the time each of those forward-looking
statements was made, the particular speaker knew that the particular forward- looking statement was
false, and/or the forward-looking statement was authorized and/or approved by an
of Tyco who knew that those statements were false when made.
FIRST CLAIM
Violation Of Section 10(b) OfThe Exchange Act Against And Rule 10b-5
Promulgated Thereunder Against All Defendants
officer
227. Plaintiffs repeat and reallege each and every allegation contained above as i f fully set
forth herein.
228. During the Class Period, Defendants, and each of them, carried out a plan scheme
and course of conduct which was intended to and, throughout the Class Period, did: (a) deceive the
investing public, including Plaintiffs and other Class members, as alleged herein; (b) artificially
inflate and maintain the market price ofTyco's securities; and (c) cause Plaintiffs and other members
of the Class to purchase Tyco's securities at artificially inflated prices. In furtherance of this
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unlawful scheme, plan and course of conduct, Defendants, and each of them, took the actions set
forth herein.
229. Defendants (a) employed devices, schemes, and artifices to defraud; (b) made untrue
statements of material fact and/or omitted to state material facts necessary to make the statements
not misleading; and (c) engaged in acts, practices, and a course of business which operated 1s a fraud
and deceit upon the purchasers of the Company's securities to maintain artificially high market
prices for Tyco's securities in violation of Section 10(b) of the Exchange Act and Rule lOb-5. All
Defendants are sued either as primary participants in the wrongful and illegal conduct charged herein
or as controlling persons as alleged below.
230. In addition to the duties of full disclosure imposed on Defendants as a result of their
issuance of affirmative statements and reports , or participation in the making of affirmative
statements and reports to the investing public, Defendants had a duty to promptly
truthful information that would be material to investors in compliance with the integrated
provisions of the SEC as embodied in SEC Regulation S-X (17 C.F.R. Sections 210.01 et seq.) and
Regulation S-K (17 C.F.R. Sections 229. 10 et seq .) and other SEC regulations , including
and truthful information with respect to the Company's operations, financial condition and
so that the market price of the Company's securities would be based on truthful, complete and
accurate information.
231. Defendants, individually and in concert, directly and indirectly, by the use, means or
instrumentalities of interstate commerce and/or of the mails, engaged and participated in a
continuous course ofconduct to conceal adverse material information about the business, operations
and future prospects of Tyco as specified herein.
-91-
232. These Defendants employed devices, schemes and artifices to defraud , while in
possession of material adverse non-public information and engaged in acts, practices , and a course
of conduct as alleged herein in an effort to assure investors of Tyco' s value and performance and
continued substantial growth, which included the making of, or the participation in the Baking of,
untrue statements of material facts and omitting to state material facts necessary in order to make the
statements made about Tyco and its business operations and future prospects in the li^ht of the
circumstances under which they were made, not misleading, as set forth more particular y herein,
and engaged in transactions , practices and a course ofbusiness which operated as a fraud d deceit
upon the purchasers of Tyco's securities during the Class Period.
233. The Defendants had actual knowledge of the misrepresentations and omi sions of
material facts set forth herein , or acted with reckless disregard for the truth in that they, failed to
ascertain and to disclose such facts, even though such facts were available to them. Such
Defendants' material misrepresentations and/or omissions were done knowingly or recklessly and
to conceal Tyco's operating condition and future business prospects from the investing public and
supporting the artificially inflated price of its securities. If Defendants did not have actual
knowledge of the misrepresentations and omissions alleged, they were reckless in failing to obtain
such knowledge by deliberately refraining from taking those steps necessary to discover'whether
those statements were false or misleading.
234. At the time of said misrepresentations and omissions , Plaintiffs and other members
of this Class were ignorant of their falsity, and believed them to be true. Had Plaintiffs and the other
members of the Class and the marketplace known of the true financial condition and business
prospects of Tyco, which were not disclosed by Defendants, Plaintiffs and other members of the
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Class would not have purchased or otherwise acquired their Tyco securities, or, ifthey ha acquired
such securities during the Class Period, they would not have done so at the artificially inflated prices
which they paid.
235. By virtue of the foregoing, Defendants violated Section 10(b) of the Exch^nge Act,
and Rule I Ob-5 promulgated thereunder.
236. As a direct and proximate result of Defendants' wrongful conduct Plaintiffs and the
other members of the Class suffered damages in connection with their purchases ofthe C
securities during the Class Period.
SECOND CLAIM
Violation Of Section 20(a) OfThe Exchange Act Against Defendants Breen and Fitzpatrick 1
237. Plaintiffs repeat and reallege each and every allegation contained above as iffully set
forth herein.
238. Defendants Breen and Fitzpatrick acted as controlling persons of Tyco ryithin the
meaning of Section 20(a) of the Exchange Act as alleged herein. Defendants Breen and Fitzpatrick
iexercised day-to-day control over Tyco and over the statements Tyco made to the public.'
239. As set forth above, Tyco violated Section 10(b) and Rule lob-5 by the acts and
omissions as alleged in this Complaint. As controlling persons of Tyco, Defendants Breen and
Fitzpatrick are liable pursuant to Section 20(a) of the Exchange Act. Asa direct and proximate result
of Defendants' wrongful conduct, Plaintiffs and other members of the Class suffered damages in
connection with their purchases of the Company's securities during the Class Period.
WHEREFORE, Plaintiffs pray for relief and judgment, as follows:
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A. Determining that this action is a proper class action, and certifying Plaintiffs as class
representatives under Rule 23 of the Federal Rules of Civil Procedure;
B. Awarding compensatory damages in favor of Plaintiffs and the other Class Members
against all Defendants, jointly and severally, for all damages sustained as a result of Defendants'
wrongdoing, in an amount to be proven at trial, including interest thereon;
C. Awarding Plaintiffs and the Class their reasonable costs and expenses incurred in this
action, including counsel fees and export fees; and
D. Such other and further relief as the Court may deem just and proper.
JURY TRIAL DEMANDED
Plaintiffs hereby demand a trial by jury.
Dated : O2ce ec , 2004 Respectfully submitted,
COOK & MOLAN, P.A.
B y:Biron BedardNH Bar No. 8758
100 Hall StreetP 0 Box 1465Concord, NH 03302-1465Tel: 603 -225-3323Fax: 603-225-8930
Proposed Liaison Counsel for Plaintiffs and
the Class
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LAW OFFICES BERNARD M.GROSS, P.C.
Deborah R. GrossRobert P. Frutkin1515 Locust Street, Second FloorPhiladelphia, PA 19102Tel: 215-561-3600Fax: 215-561-3000
BERNSTEIN LIEBHARD &LIFSHITZ, LLPSandy LiebhardKeith Fleischman
Seth Ottensoser10 East 40"' StreetNew York, New York 10016Tel: 212-779-1414Fax: 212-779-3218
VIANALE & VIANALE LLPKenneth J. VianaleJulie Prag VianaleThe Plaza - Suite 8015355 Town Center RoadBoca Raton, FL 33486Tel: 561-391-4900Fax: 561-368-9274
Proposed Lead Counselfor Plaintiffs ind theClass
-95-
iii
iI.
i
CERi CATION OF NAMED FLAINrITU31VAM-TOEVVM&ffA3M= AM
THE E CHARTABLETRUST, ("Plaintiff), decisres the following as to the chin asserted und or the
federal securities laws, that:
1. Plaintiffhas reviewed the complaint filed in this matter and is authorized the filing of acomplaint bawd an similar allegations in a related or amended complaint. P: nintiff retains Bernstein Liab &Litshita, U.P and such co-counsel it deems appropriate to associate with to 'u+tsae such action on a aonti tfee basis.
2. Plaintiff did not purchase the ty that is the eut oct of t Ids action at the direction ofPlaintifFs counsel ear in order to participate in this private action.
3. Plaintiff is willing to serve as u lad plaintiff either indivbii ally eras Part. of t gr+oap. A lplaintiff is R ^esentttiva party who acts on behalf ofodw class mcmbert in directing e action, anddutkx may include t idling at deposition and tel. I understand that the k ligation is not settled, this is wt aclaim fo:m, and sharing in any recovery Is not depcndeat upon caecuton o: • this Certification.
4. Plaintiff's transaction(:} in the TYCOINTERNATIONAL Liu. se ty that is the subject ctthislotion durisu the chr .od arc as l^ilowE: - -'
11-frMM_TYC_ _Bu^ V .7AD3 517.98TYC Sail IM/03 $15.00
^Lt a artrawctlie^ ^n a sealsIhirt *aprer.Unaeeii i - _ " .~- .-. _......
5. Dung the ftw years prior to the date ofthis Certificatio i, Plaintiff lies not sought to orsaved as a representative party for the class In any action Shed under the I idend securities laws except asindicated . The Ezra C3uritab)e Trust v. Fruit ofthe Loom, be., The I an Charitable Trust v. Franticinawance Group, The Faa Charitabl Trust v. RentWay, Inc ., the Eaa 4 :humble Trust v. Verdeal Net, TheEzra Charitable Trust v. interstate Biketics Cwp.. The Ezra Charitable Tr ant v. Heaithsouth Corporatiame, ;andThe Ezra Charitable Trutt Y. A lou Hcatdmr; Inc.b 100 on 1117/03 at 17.98 i 121/03 at 15
6. Plaintiff has complete investment authority and is the agile it and attomcy-in-fact with full ioweand authority to bring suit to recover for investment losses.
The is authorized to sign this Certification o i behalf ofPlaintiff.
8. Plaintiffwill not accept any payment for saving as atop ro tative party on behalf of t^q classbeyond the PWndWi pro share ofany s^ecovery, or as ordered or apf roved by the court, including ^raward for r sionable costs and expenses (including lost wages.) directly r elating to the representation oftheclass.
I declare under penalty of pet guy that the foregoing is true and c watt.
Executed this 27th day ofMay, 2003.
WIO^Le MUST
Vianale & Vianale LLP5355 Town Center Road, Suit? 801Boca Raton, Pt. 33486Tel.: 561-391-4906/Fax: 561-368-9274
CERTIFICATION OF PLAINTIFFPURSUANT TO FEDERAL SECURITIES LAWS
Re: TYCO INTERNATIONAL, LTD. NYSE: TY
MIRROR MANAGEMENT LIMITED ("Plaintiff") declares:
1. Plaintiff has reviewed a complaint and authorized its filing.
2. Plaintiff did not purchase the security that is the subject of this action at
the direction of plaintiff's counsel or in order to participate in this private action or any
other litigation under the federal securities laws.
3. Plaintiff is willing to serve as a representative party on behalf of the class,
including providing testimony at deposition and trial, if necessary.
4. Plaintiff has made no transaction(s) during the Class Period in the debt or
equity securities that are the subject of this action except those set forth below (use a
separate sheet if necessary)
Date TransactionType (Buy or Sell)
# of Shares Price PerShare
1/10/03 BUY 2200 $40.00
2/6/03 BUY 1200 $40.00
3/25/03 BUY 100 $40.00
S. During the three years prior to the date of this Certificate, Plaintiff has
sought to serve or served as a representative party for a class in the following action
filed under the federal securities laws:
NONE
6. The Plaintiff will not accept any payment for serving as a representative
party on behalf of the class beyond the Plaintiff's pro rata share of any recovery, exc pt
such reasonable costs and expenses (including lost wages) directly relating to the
representation of the class as ordered or approved by the court.
I declare under penalty of pezjury that the foregoing is true and correct.
Executed this `day of Y'2003.
r
Mirror Mana ern t meted
By:Roher, President