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SEC Charges Three Ex-Tyco Finance Execs

The regulator accuses the trio of being part of a sham transaction, inflating results, smoothing reserves, and fiddling with acquisition accounting.
Stephen TaubDecember 22, 2006

The Securities and Exchange Commission has charged two former Tyco International finance executives with fraud, and settled charges with a third.

The regulator says it filed a civil injunctive action in the U.S. District Court for the Southern District of New York against Richard D. Power, a former vice president and onetime chief financial officer of Tyco, and Edward Federman, former executive vice president and chief financial officer of the Tyco Electronics unit. The SEC alleges that the duo designed and implemented fraudulent accounting practices at Tyco and thereby violated the antifraud and record-keeping provisions of federal securities laws, as well as aided and abetted Tyco’s violations of the antifraud, reporting, and record-keeping provisions.

The complaint also charges that Richard J. “Skip” Heger, who was responsible for the financial results of the Tyco division that included the company’s security-monitoring business, also violated the record-keeping provisions of U.S. securities laws and aided and abetted Tyco’s violations of the reporting and record-keeping provisions.

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Heger, without admitting or denying the complaint’s allegations, has consented to the entry of a proposed final judgment permanently enjoining him from further violating the record-keeping provisions and from aiding and abetting violations of the reporting and record-keeping provisions of the federal securities laws. He also was ordered to pay $450,000, including disgorgement of $300,000, prejudgment interest of $100,000, and a penalty of $50,000.

The commission says it intends to have any disgorgement, prejudgment interest, or penalty amounts paid into the Fair Fund, under Section 308(a) of the Sarbanes-Oxley Act.

The complaint against Power and Federman seeks permanent injunctions, and disgorgement with prejudgment interest and penalties, from each of the individuals, as well as an order barring them from serving as an officer or director of a public company.

The commission’s complaint notes 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 its ADT Security Services 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,” read the complaint. The SEC asserted. “No additional money changed hands as a result of the dealer connection fee transaction.”

The SEC accused Power of designing the sham transaction immediately following Tyco’s 1997 merger with ADT. Further, the regulator alleges that 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 SEC added. The commission claims 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 also charges that Power and Federman further inflated Tyco’s operating income using fraudulent acquisition accounting, including the preacquisition reduction of asset valuations and overstatement of liabilities in connection with several of Tyco’s most significant business acquisitions. It also accuses Federman of engaging 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.

The SEC asserts that Heger approved division financial results “that he knew, or was reckless in not knowing” had been inflated by the sham transaction and improper acquisition accounting and that had been enhanced or smoothed by the improper use of reserves.