Livent, Inc: an Instructional Case

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LIVENT, INC.: An Instructional Case

Michael C. Knapp Professor University of Oklahoma

Price College of Business 307 W. Brooks Norman, Oklahoma 73019

Office phone: 405-325-5784 mknapp@ou.edu

Carol A. Knapp Visiting Associate Professor University of Oklahoma

Price College of Business 307 W. Brooks Norman, Oklahoma 73019

ABSTRACT: Like many financial frauds, the Livent, Inc. fraud was masterminded by a few individuals, primarily Garth Drabinsky, a Broadway “impresario” who had received several Tony Awards for Livent’s theatrical productions. However, numerous individuals were eventually drawn into Livent’s fraudulent schemes by Drabinsky. The Livent fraud unraveled following the takeover of the company by an investment group headed by former Hollywood power broker and Disney executive, Michael Ovitz. Shortly after assuming control of Livent, Ovitz’s new management team reported “massive, systematic, accounting irregularities that permeated the company.” 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, the company’s accounting staff developed computer software to allow senior management to track both Livent’s “real” numbers and the fraudulent manipulations of those numbers. Once the manipulations were created, the so-called accounting “adjustments” appeared in Livent’s accounting records as if they were the original transactions, thus eliminating a paper trail. The second troubling feature of the Livent fraud was the matter-of-fact manner in which the company’s management team and accountants organized and carried out the fraud. The Livent scandal had several features shared with other major financial frauds. These common features included an extremely aggressive, growth-oriented management team, a history of prior financial reporting indiscretions by top management, 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.

Key Words: Auditing, Fraud, Audit Failure, Litigation.

LIVENT, INC.: An Instructional Case

The structure of a play is always the story of how the birds came home to roost.

Arthur Miller

In May of 1996, Canadian native Maria Messina stood at an important crossroads in her professional career. Just one year earlier, the 34-year-old Chartered Accountant had achieved one of the most sought after career goals in the public accounting profession when she was promoted to partner with Deloitte & Touche, Chartered Accountants, the Canadian affiliate of the U.S.-based Deloitte & Touche, LLP. Messina’s promotion had earned her the respect and admiration of her family, her friends, and her colleagues in the profession. Her new position also came with a sizable increase in take-home pay that catapulted her to a much higher tax bracket and a more comfortable standard of living. But, another opportunity had just arisen, an opportunity that promised even more intrinsic and extrinsic rewards for Messina.1 Throughout the 1990s, Livent, Inc., was the only publicly owned company whose primary line of business was live theatrical productions. Livent’s co-founder and the individual recognized as the creative genius responsible for the company’s impressive string of Tony Award-winning shows was Garth Drabinsky. Livent’s audit firm was Deloitte & Touche, Chartered Accountants. Maria Messina served as the engagement partner for the 1996 audit, after having been the audit manager on prior audits of the company. Following the completion of the 1996 Livent audit, Drabinsky asked Messina to leave Deloitte & Touche and become Livent’s chief...
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