CASE 8.1
LIVENT, INC.
Synopsis
Similar to most financial frauds, the Livent, Inc. fraud was masterminded by a few individuals,
primarily Garth Drabinsky and Myron Gottlieb. However, numerous individuals were eventually
drawn into Livent’s fraudulent schemes by its principal architects, including Maria Messina, the
company’s chief financial officer (CFO). Messina, a former partner with Deloitte & Touche’s
Canadian affiliate, had previously served as Livent’s audit engagement partner. The fraud unraveled
following Livent’s takeover by an investment group led by Hollywood mogul Michael Ovitz. The
new management team installed by Ovitz soon found that fimassive, systematic irregularities”
the fraud.
Following the collapse of Livent, the company’s independent auditors were criticized for failing
to discover that the company’s financial statements had been grossly misstated. Much of this
criticism stemmed from the fact that the Livent fraud had features common to several ficlassic”
financial frauds. These features included an extremely aggressive, growth-oriented management
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Livent, Inc.—Key Facts
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1. Garth Drabinsky and Myron Gottlieb founded Livent in 1989 after they had been forced to
relinquish control of Cineplex Odeon following charges of irregularities in that company’s
accounting records.
2. Drabinsky was the creative genius behind Livent’s impressive string of Tony Award-winning
4. Serious financial problems stemming from huge cost overruns on Livent’s extravagant
5. Ovitz’s new management team quickly found that Livent’s previous financial data had been
grossly distorted by pervasive accounting irregularities.
6. Subsequent investigations by the SEC and other law enforcement authorities revealed that
7. Livent employees who participated in the fraud included several accountants who had
8. The SEC discovered that Livent’s accounting staff had developed computer software that
10. The fiaccounting manipulations” used by Livent officials included simply erasing expenses and
11. In August 1998, Messina and four of her subordinates revealed the fraud to a Livent executive
who had been appointed by Michael Ovitz.
Instructional Objectives
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2. To illustrate the lengths to which client management will sometimes go to misrepresent its
company’s operating results and financial position.
Suggestions for Use
In responding to Question 1, students are required to identify the audit risk factors posed by
companies in the entertainment industry. Consider expanding Question 1 and making it a more
comprehensive exercise. After organizing your class into groups of four to six students, require each
group to investigate and prepare a five- to ten-minute oral report on the audit risk factors posed by a
Maria Messina, the Deloitte audit partner who became Livent’s CFO, is a key character in this
case. At press time, federal authorities in the United States had yet to decide on what punishment
Messina would receive for her role in the Livent fraud. Before covering this case, you might do a
quick Internet search to determine whether Messina’s case has been resolved.
In discussing Messina’s plight (while responding to Question 6), some students are prone to
suggest that she should have simply reported the fraud to the appropriate officials as soon as she
Suggested Solutions to Case Questions
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1. The fientertainment industry” is very diverse and fragmented. In fact, there is little consensus
among financial analysts on which specific companies belong to this industry. Video game
manufacturers, movie production companies, publicly owned sports franchises, and sporting goods
manufacturers are a just a few examples of the types of companies that are involved in fientertaining”
the public. Nevertheless, I would suggest that many companies in the entertainment industry pose
the following general inherent risk factors:
•Entertainment companies tend to have more volatile operating results than more generic
companies. Why? Because most companies in this industry rely heavily on discretionary
spending by consumers, which fluctuates with changes in the overall health of the economy.
Listed next are a few examples of finon–standard” audit procedures that might be applied during
an audit of a company involved in live theatrical productions.
•Internal control tests would be necessary to ensure that cash receipts generated by live shows
are being processed properly. Likewise, related tests would be needed to reconcile head counts
with cash receipts—to investigate the possibility that ticket-takers/ticker-sellers are being
figenerous” with their friends and relatives.
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Auditors would need to develop audit tests to address the key assertions underlying these
amounts. For example, a potentially career-ending injury or illness to an actor who has been
2. The work roles of an audit partner and CFO of a large public company are probably more
similar than they are different. Both an audit engagement partner and a CFO have to fisign off” on
financial statements. An audit partner attests to the material accuracy of a client’s financial
statements when he or she signs an audit report. Since the summer of 2002, the SEC has required
CEOs and CFOs to sign an oath attesting to the accuracy of financial statements filed by their
companies with the SEC under the Securities Exchange Act of 1934. Both audit partners and CFOs
supervise numerous subordinates and assume responsibility for the work product of those
subordinates, have an obligation to fistay current” regarding key technical developments within the
accounting and financial reporting domain, and face potential civil and criminal sanctions if they fail
3. Most corporate executives are honest and insist that their accounting subordinates be honest and
diligent in maintaining a company’s accounting records and in preparing its periodic financial
statements. As a result, corporate executives often perceive that an audit contributes nothing to the
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One effective way for auditors to create a value-added dimension to their audits in the minds of
corporate executives is to prepare a management letter or other formal communication at the
4. The relevant standards in this context are SAS No. 50, fiReports on the Application of
Accounting Principles,” and SAS No. 97, fiAmendment to Statement No. 50, Reports on the
Application of Accounting Principles.” (Notes: Recognize that SAS 97 was issued in June 2002,
The simple answer to this question is that the fireporting accountant” must figet the facts” before
issuing a report on the given issue. More specifically, AU Section 625.08 lists the following four
general procedures that a reporting accountant should perform before forming a judgment regarding
the given issue.
•Obtain an understanding of the form and substance of the transaction(s)
5. The revenue recognition principle is the key accounting concept that is relevant to this context.
Generally, the revenue recognition principle dictates that revenue must be both fiearned” and
firealized” before it can be recorded. fiEarned” means that the relevant earnings process must be
6. Messina did not feel directly responsible for the accounting irregularities. However, because
she had chosen to work for an organization that was replete with fraudulent conduct, she apparently
fiabsorbed” some measure of guilt or responsibility for those irregularities.
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7. AU Section 634 provides general guidance for accountants to follow when performing a wide
range of due diligence engagements, including such engagements that involve common fiacquisition
transactions.” (AU 634.05). [Note: Since due diligence investigations are not audits, the term