At Livent, Is Fraud The Thing?
Each time Maria Messina walked down the hall of the executive suite at Livent Inc. in late 1997, she looked a little more strained, recalls Marty Bell, Livent's former senior vice-president for creative affairs. As a vice-president and chief financial officer at the financially strapped Broadway producer, Messina would naturally be under some pressure. But to Bell, it seemed as if all the weight of the Toronto-based company's problems fell on her shoulders. "I could tell something was getting to her," Bell recalls, noting that Messina at other times had discussed the stresses of her work. "She was carrying around something she wouldn't talk about."
Now, Bell and other former Livent colleagues know just how much of a burden Messina was carrying. Messina, who joined Livent in 1996 after serving as its outside auditor at Deloitte & Touche since 1993, had been immersed in what the Securities & Exchange Commission charges was "a multifaceted and pervasive accounting fraud." For her role in helping carry out the alleged scheme, Messina pleaded guilty on Jan. 7 to a federal felony charge. The 36-year-old single mother of a 10-year-old girl now faces up to five years in jail and fines as high as $250,000. She declined to discuss the case.
"EGREGIOUS." As described in court papers filed in the U.S. and Canada, the allegations surrounding Livent provide a disturbing look at how outside auditors can be hoodwinked by managers determined to cook the books. The case also offers an unsettling example of an independent auditor who was lured to a client--an all-too-common move that worries regulators because they believe the opportunity might tempt an auditor to tread lightly. In Livent's case, Messina even joined the scheme later. Says SEC enforcement director Richard H. Walker: "This is one of the most extreme and egregious types of cases."
Messina and five other former Livent insiders who have turned state's evidence in the case were just supporting actors, according to the U.S. Attorney's Office in New York and separate lawsuits filed by the SEC and new management at Livent. The alleged fraud, the authorities say, was directed by Livent founder and ex-Chief Executive Officer Garth H. Drabinsky and his longtime partner, former Livent President Myron I. Gottlieb. Drabinsky and Gottlieb built a $200 million company, with the concept of bringing corporate management to Broadway, along with such award-winning shows as Ragtime. Now, both are targets of a federal indictment.
Drabinsky and Gottlieb deny the charges, claiming they spring from a conspiracy to drive them out of Livent orchestrated by Roy Furman, the company's current chairman and CEO, and Hollywood investor and former Disney President Michael S. Ovitz. In November, they filed a countersuit in Toronto against Livent's current management. "We knew of no alleged illegal accounting practices," Drabinsky said at a press conference after the indictment was announced on Jan. 13. Neither would comment on specific allegations. A Livent spokesman says present management believes the felony indictment of the pair "makes very clear what happened."
By using specially tailored software to carry out exhaustive manipulations, the SEC alleges, the top Livent executives masked losses and shifted costs, dressing up results well enough to enable them to raise more than $179 million in public equity and debt markets. At first, a chief goal of Livent's accountants appears to have been to fool outside auditors, as described by the SEC. Had Livent execs been recording changes in individual journal entries, for instance, that would have raised a red flag. So, regulators allege, Livent's senior vice-president for finance, Gordon C. Eckstein, in 1994 had information-management staffers write a computer program that would let accountants make wholesale adjustments on millions of dollars of invoices.
Eckstein and his colleagues also sought to hide theatrical disappointments, the SEC charges. From 1994 on, they allegedly shifted costs from the failed Sunset Boulevard to shows in development, such as Show Boat. Eckstein, who refused comment, pleaded guilty on Dec. 30 to a federal charge of conspiring with Drabinsky and Gottlieb to manipulate Livent's results. More recently, he consented to an SEC injunction against breaking securities laws, and he is now cooperating with the government.
GARBAGE IN. As described by the U.S. attorney, Messina and her colleagues at Deloitte combed the company's reports routinely before signing off on them each year. As auditors typically do, they scanned accounts payable, reviewed schedules of preproduction costs, examined fixed-asset accounts, and sought written assurances from Livent managers about the accuracy of the figures. Their goal: to make sure the figures met accounting standards. But they didn't know, authorities say, that the records had been doctored.
The manipulations were so exhaustive, the government charges, that Eckstein insisted that Livent keep two sets of books. From 1995 to 1998, Senior Controller D. Grant Malcolm allegedly maintained computer files of the changes to keep track of Livent's true finances. The SEC charges that he had to "distinguish between the real and phony numbers." Malcolm has consented to an SEC injunction against securities violations without admitting or denying the allegations. He is cooperating with the SEC's ongoing investigation. Eckstein, alleges the SEC, fully briefed Drabinsky on the manipulations.
Shouldn't Deloitte have caught such massive fraud? That's the common perception, says Ramy Elitzur, an accountant and former auditor who teaches at the University of Toronto's Rotman School of Management. But under current U.S. and Canadian accounting practices, auditors are obligated only to ensure that financial statements are prepared in line with generally accepted accounting principles and report fraud if, while following those standards, they find it. "When management conspires, it's very, very difficult for auditors to detect fraud," Elitzur says. Deloitte says it followed standard accounting principles. And it continues to audit Livent's books.
Messina seems to have been kept in the dark while at Deloitte. But she admitted in her plea that she eventually joined in the scheme after arriving at Livent. The SEC alleges that in 1996, the year she was hired, she helped keep her former Deloitte colleagues from learning of certain fees Livent had to pay for the rights to perform Show Boat. Those fees would have hiked reported liabilities, the SEC says. Messina disputes that she knew what was going on in 1996, and she has not settled the SEC charges. But she doesn't disagree that by October, 1997, she had learned about such manipulations as the "expense roll," where Livent accountants erased expenses in one quarter and entered them in the next one. Rather than protest, Messina signed the falsified statements crucial to Livent's $125 million debt offering in 1997, she admitted in her federal guilty plea.
While Messina declined comment, her friend Bell believes she felt trapped and intimidated. "She was probably bullied into it," says Bell, who was let go in a cost-related downsizing last fall. But the SEC takes a tougher view, saying Messina should have quit or blown the whistle to the Livent board or to outside authorities. Argues Walker: "There's always, always people to complain to."
NEW GUY. The SEC says the scheme began unraveling for financially strapped Livent in mid-1998, when Drabinsky agreed to bring in longtime friend--and now critic--Furman, a founding partner of brokerage Furman Selz Inc., as CEO. Furman persuaded Ovitz to invest $20 million. Ovitz, in turn, brought in accounting heavyweight Robert B. Webster from KPMG Peat Marwick. As described in court papers filed in Canada by Livent, Webster was troubled last July by staffers' reluctance to deal with him. Drabinsky, he heard, was telling them to hold back information. Late on Aug. 6, Messina and four others--not including Eckstein--came forward. Webster questioned them for two days and then briefed the board. Drabinsky and Gottlieb were promptly suspended. By November, they had been fired, and Livent plunged into bankruptcy reorganization.
For Messina and her colleagues, Broadway glitz has turned tawdry. Despite their cooperation and over the objections of current management, all five who went to Webster were let go at the demand of the SEC. "A whistle-blower is a good soldier to one person and a person who's created a fraud to another," says the SEC's Walker. "We charged them with fraud."
Livent's legal drama could play far longer than some of its Broadway productions. And when the curtain finally drops, Livent will leave behind a sobering script on the failure of accounting safeguards and ethics.