Dennis Kozlowski

The fraud was not exotic. A public company paid for a CEO's apartment, his wife's birthday party in Sardinia, and a shower curtain that cost $6,000. The company's board approved these payments — or appeared to, because the documentation said so. The documentation was false because Kozlowski had written it.

L. Dennis Kozlowski joined Tyco International in 1975 and rose to CEO. By the late 1990s he had built Tyco into one of the largest conglomerates in the world — diversified manufacturing, fire protection, electronics. The company was real. Its earnings were substantial. The fraud was not in the earnings; it was in what the CEO took out of the company for himself.

The prosecution established two categories of conduct. First: unauthorized compensation — bonuses, loans that were never repaid, and expense reimbursements that the board had not approved and that were structured to look as if it had. Second: falsified records — documentation created or altered to make unauthorized payments appear to have proper board authorization. The first category is self-dealing; the second is fraud.

The first trial, in 2004, ended in a mistrial after a juror received a letter about the case. The retrial produced a conviction on June 17, 2005. Kozlowski and CFO Mark Swartz were each sentenced to 8 years 4 months to 25 years on September 19, 2005, in New York State Supreme Court in Manhattan; Kozlowski was also fined $70 million. The case was brought by the Manhattan District Attorney under state law — grand larceny, securities fraud and falsifying business records. Kozlowski was paroled in January 2014 after serving approximately 8.5 years. [SOURCE: DOJ; CNBC; Wikipedia]

The famous details of this case — the $6,000 shower curtain, the $2 million birthday party for his wife staged in Sardinia and billed in part to Tyco, the Fifth Avenue apartment — were presented at trial as evidence, not as tabloid colour. They served a purpose: to demonstrate the scale of the self-dealing and to show the jury what the unauthorized payments were for.

The shower curtain was part of an apartment that Tyco paid for in New York City. The birthday party — a week-long event in Sardinia for Karen Kozlowski's 40th birthday, attended by business contacts alongside family and friends — was billed partially as a corporate function. Both are in the trial record because both were presented as examples of the kind of expenditure that was being run through the company under falsified authorizations.

The point the prosecution made: these expenditures are what the money was for. Not sophisticated financial manipulation — actual spending, on real things, that a CEO decided a public company owed him without his shareholders or his board having approved it.

The mechanism by which Kozlowski concealed the unauthorized compensation was the falsification of internal records — specifically, the creation of documentation purporting to show board approval for loans and compensation that the board had not approved.

This is the same governance theme the series returns to in Leeson (022), in Kerviel (030), and in the machine-gate framework: a control can be forged. If the person committing the fraud is also the person generating the authorization, the control does not check the conduct. It certifies it.

The board's independent oversight function — the audit committee, the compensation committee, the governance structure that was supposed to prevent exactly this — was bypassed not by breaking it, but by producing false documentation that it appeared to have operated normally. The records said the board approved it. The board had not approved it.

Sarbanes-Oxley (produced by the Ebbers/WorldCom case in 2002) was already law by the time Kozlowski was convicted in 2005. Its personal-certification requirements — CEOs and CFOs signing off on financial statements under criminal penalty — are a response to precisely the conduct Kozlowski engaged in.