Audit Knapp Answer

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CASE 8.1



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 “massive, systematic irregularities” permeated the company’s accounting records. Subsequent investigations by various regulatory authorities, including the SEC, resulted in numerous civil lawsuits and criminal indictments being filed against Drabinsky and his former associates. Two features of the Livent fraud were particularly disturbing to SEC officials. First, Livent’s accounting staff helped further the fraud by developing computer software that allowed senior management to track the company’s “real” financial data and the data that had been distorted by fraudulent manipulations. The accounting software also allowed Livent’s executives to more readily conceal the fraud from the company’s Deloitte auditors. The second troubling feature of the Livent fraud was the matter-of-fact manner in which the company’s executives organized and carried out 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 “classic” financial frauds. These features included an extremely aggressive, growth-oriented management team, a history of prior financial reporting indiscretions by top company officials, a constant and growing need for additional capital, and the existence of related-party transactions. The presence of these “red flags” should cause auditors to recognize that there is a higher than normal risk that the given client’s financial statements may contain material misstatements.

Livent, Inc.—Key Facts

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 theatrical productions during the 1990s but also dominated, with the help of Gottlieb, every other important facet of Livent’s operations.

3.Livent was based in Toronto but the company received SEC approval to begin trading its stock on the NASDAQ stock exchange in 1995.

4.Serious financial problems stemming from huge cost overruns on Livent’s extravagant productions forced Drabinsky to allow Michael Ovitz to acquire a controlling interest in the company in 1998.

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 Drabinsky and Gottlieb had apparently masterminded a far-reaching and multi-faceted financial fraud to conceal Livent’s deteriorating financial health.

7.Livent employees who participated in the fraud included several accountants who had previously served on Deloitte’s audit engagement team for the company; most notably Maria Messina, Livent’s CFO who had previously been the company’s audit engagement partner.

8. The SEC discovered that Livent’s accounting staff had developed computer software that tracked the company’s “real” and bogus financial data; this software was also used to conceal the fraud from the...
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