Friday, December 22, 2006
The SEC sued two former Tyco Inc. executives for fraud, and it's not the well-known former CEO Dennis Kozlowski and former CFO Mark Swartz, who are serving time after their convictions for grand larceny for diverting money from the company. Instead, the Commission sued Richard D. Power and Edward Federman for their role in a scheme to pump up the company's revenue through a sham transaction that was allegedly at the behest of Kozlowski and Swartz. According the the SEC Litigation Release (here):
The Commission's complaint alleges that Power and Federman inflated Tyco's operating income by hundreds of millions of dollars through the use of a sham transaction. In that transaction, Tyco charged authorized dealers of Tyco's ADT Security Services, Inc. (ADT) subsidiary a "dealer connection fee" whenever the company purchased security monitoring contracts from them. However, the connection fee was fully offset by a simultaneous increase in the purchase price ADT allocated to the dealers' security monitoring contracts. Thus, the transaction lacked economic substance. No additional money changed hands as a result of the dealer connection fee transaction. The sham transaction was designed by Power immediately following Tyco's 1997 merger with ADT Ltd. Federman subsequently defended the transaction when concerns were raised in meetings with Tyco's independent accountant. His defense was successful, and the income inflation from the transaction continued unabated. The complaint alleges that the transaction inflated Tyco's operating income by $567 million from the company's fiscal year 1998 through its fiscal quarter ended December 31, 2002.
The complaint alleges that Power and Federman further inflated Tyco's operating income by means of fraudulent acquisition accounting, including the pre-acquisition reduction of asset valuations and overstatement of liabilities in connection with several of Tyco's most significant business acquisitions. In addition, Federman engaged in the improper use of accounting reserves to enhance Tyco's reported financial results, directing the reversal of reserves at Tyco's fiscal year-end to offset an unanticipated $40 million compensation expense.
A third executive responsible for booking the transactions, Richard (Skip) Heger, settled the SEC case by agreeing to pay $450,000 in disgorgement, interest, and a civil penalty. Tyco settled an SEC enforcement action in April 2006 (Litigation Release here) related to the same transactions and paid a $50 million civil penalty. Securities fraud charges against Kozlowski and Swartz are still pending. (ph)