UPDATE 1-Michigan sues Tyco to protect state funds

(Adds details from lawsuit, comment from Tyco)

NEW YORK, Feb 8 (Reuters) - The state of Michigan sued Tyco (TYC.N) on Friday, alleging that the company, its auditors and former executives participated in a massive corporate fraud that depleted state pension funds.

The state had been a plaintiff in a class action lawsuit along with other Tyco shareholders but opted out of a settlement to pursue its own claims, Attorney General spokesman Rusty Hills said.

"As we looked at that (proposed settlement) those of us felt we could do better," Hills said.

The complaint, filed in the Eastern District of Michigan, alleges Tyco continually inflated its earnings and manipulated its books to hide "excessive" executive compensation.

Minnesota Attorney General Mike Cox also accused the manufacturing conglomerate of using improper accounting practices that company insiders described as "financial engineering" to mislead investors, including the state pension funds.

Former Tyco CEO Dennis Kozlowski and CFO Mark Swartz were found guilty in June 2005 of stealing millions from the conglomerate, a case that became infamous amid revelations that Kozlowski had used company funds to pay for a $15,000 umbrella stand and a $6,000 shower curtain.

A Tyco spokesman could not be reached for comment on the Michigan case.

The funds and their 600,000 participants and beneficiaries lost more than $50 million from their Tyco shares' 2001 peak after the accounting scheme unraveled, Cox said.

The funds, which invest on behalf of state and public school employees, police and judges, hold combined assets of $62 billion. (Reporting by Edward Tobin; Editing by Tim Dobbyn, Richard Chang)