SECURITIES ACT OF 1933
Release No. 7627 / January 13, 1999
SECURITIES EXCHANGE ACT OF 1934
Release No. 40937 / January 13, 1999
ACCOUNTING AND AUDITING ENFORCEMENT
Release No. 1095 / January 13, 1999
File No. 3-9806
|In the Matter of
|ORDER INSTITUTING PUBLIC
PROCEEDINGS PURSUANT TO
SECTION 8A OF THE SECURITIES
ACT OF 1933 AND SECTION 21C OF THE
SECURITIES EXCHANGE ACT OF 1934,
MAKING FINDINGS AND IMPOSING A
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and hereby are, instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Livent Inc. ("Livent" or the "respondent").
In anticipation of the institution of these proceedings, Livent has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings, and any other proceedings brought by or on behalf of the Commission, or in which the Commission is a party, without admitting or denying the findings set forth below, except as to jurisdiction of the Commission over it and over the subject matter of these proceedings, which the respondent admits, the respondent consents to the entry of this Order Instituting Public Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934, Making Findings and Imposing a Cease-and-Desist Order ("Order") set forth below.
The Commission makes the following findings 1 :
Liventis a Toronto, Ontario company that produces live theatrical entertainment, such as Ragtime, The Phantom of the Opera, Show Boat, Sunset Boulevard and Fosse, and owns and operates theaters in Toronto, Vancouver, Chicago and New York. Livent became a public company in Canada in May 1993, and pursuant to Section 12(g) of the Exchange Act, registered its common stock with the Commission in May 1995. Livent's stock is traded on the NASDAQ national stock market and on the Toronto Stock Exchange. On November 18 and 19, 1998, respectively, Livent declared bankruptcy in the United States and Canada.
The former senior management of Livent engaged in a multi-faceted and pervasive accounting fraud spanning eight years from 1990 through the first quarter of 1998. Garth Drabinsky ("Drabinsky"), Livent's former Chairman and Chief Executive Officer, and Myron Gottlieb ("Gottlieb"), the company's former President and a director, were the architects of a fraud which included: a multi-million dollar kick-back scheme designed to misappropriate funds for their own use; the improper shifting of preproduction costs, such as advertising for Ragtime, to fixed assets, such as the construction of theaters in Chicago and New York; and the improper recording of revenue for transactions that contained side agreements purposefully concealed from Livent's independent auditors.
Drabinsky and Gottlieb manipulated income and operating cash flows throughout the relevant period with the active participation of several long-time associates, including Gordon Eckstein ("Eckstein"), Livent's former Senior Vice President of Finance and Administration, Robert Topol ("Topol"), the company's former Senior Executive Vice President and Chief Operating Officer, as well as several individuals in the company's accounting department. Maria Messina ("Messina"), Livent's Chief Financial Officer, and former Deloitte & Touche ("Deloitte") engagement partner for Livent's 1995 audit, also participated in the fraudulent scheme. Drabinsky and Gottlieb also enlisted the support and assistance of numerous Livent personnel in their far-reaching fraud and solicited assistance from various other individuals and entities to facilitate and conceal the fraud. While in possession of material nonpublic information concerning the fraudulent conduct at Livent, two former senior officers and three former accounting staff members of Livent engaged in insider trading of Livent securities.
In August 1998, NASDAQ and the Toronto Stock Exchange halted trading in Livent after new management discovered and disclosed the existence of serious accounting irregularities at Livent and retained KPMG Peat Marwick to conduct an independent investigation of such irregularities.aspects of the fraud. In November 1998, following the independent investigationconducted by KPMG Peat Marwick, Livent restated the company's financial statements for the years 1996 through the first quarter of 1998. Livent's restatement resulted in a cumulative adverse effect on net income in excess of $98 million (Cdn). 2 When trading briefly resumed following restatement, Livent stock plummeted over ninety-five percent from $6.75 (US) per share to approximately $.28 cents per share, and lost over $100 million (US) in market capitalization.
Former senior management's manipulation of income for eight years caused Livent to file with the Commission materially false and misleading financial statements and disclosures in at least seventeen filings during the company's first three fiscal years as a publicly traded company in the United States, 1995, 1996 and 1997, as well as the first quarter of its fiscal year 1998. These filings included: annual and quarterly reports filed during the time period 1995 through 1998; Livent's 1995 registration of 12 million common shares;1998; a a $35 million (US) equity offering of 3.75 million common shares in 1996; and a $125 million (US) debt offering in 1997.
As a result of the scheme, Livent's financial statements for fiscal years 1991 and 1992, prior to Livent becoming a U.S. public company, were materially false and misleading in that Livent overstated pre-tax earnings, or understated pre-tax losses, in each of those years. For fiscal 1991, Livent reported a pre-tax loss of $1.2 million. In fact, Livent's loss in that year was approximately $4.6 million. For fiscal 1992, Livent reported pre-tax earnings of $2.9 million. In fact, the company's true earnings were approximately $100,000.
As a further result of the scheme, Livent reported inflated pre-tax earnings, or understated pre-tax losses, for each of its fiscal years as a U.S. public company, 1995 through 1997. For fiscal 1995, Livent reported pre-tax earnings of $18.2 million. In fact, the company's true earnings were approximately $15 million. For fiscal 1996, Livent reported pre-tax earnings of $14.2 million. In fact, the company incurred a loss of more than $20 million in that year. For fiscal 1997, Livent reported a pre-tax loss of $62.1 million. In fact, the company's true loss in fiscal 1997 was at least $83.6 million.
As a further result of the scheme, Livent reported fixed assets that were fraudulently overstated for fiscal years 1994 through 1997. For fiscal 1994, 1995 and 1996, respectively, Livent reported fixed assets of $78 million, $80.8 million and $133.2 million. In fact, these amounts were overstated by at least $5 million in fiscal 1994 and 1995, and $6 million in 1996. For fiscal 1997, Livent reported $200.8 million in fixed assets, which was materially overstated by at least $23.9 million.
As a further result of the scheme, Livent reported preproduction costs or fixed assets that were fraudulently overstated for fiscal years 1994 through 1997. For fiscal 1994, 1995 and 1996, respectively, Livent reported preproduction costs of $28 million, $55.4 million and $75.6 million. In fact, each of these amounts was overstated by approximately $4 million. In addition, for fiscal 1996, Livent reported fixed assets of $133.2 million, which was overstated by at least $6 million. For fiscal 1997, Livent reported fixed assets of $200.8 million, which was materially overstated by approximately $23.9 million.
C.Drabinsky and Gottlieb's Fraudulent Kickbacks
Drabinsky and Gottlieb began their elaborate fraud even before Livent became a U.S. public company in 1995. As early as 1990, and continuing through 1994, Drabinsky and Gottlieb operated a kickback scheme with two Livent vendors designed to siphon millions of dollars from the company directly into their own pockets.
Drabinsky and Gottlieb orchestrated the kickback fraud by enlisting Peter Kofman ("Kofman"), a Canadian engineer, and Roy Wayment ("Wayment"), owner of a Canadian construction company, to artificially inflate invoices. Gottlieb specified to the vendors the bogus descriptions of the services rendered for insertion in the invoices, as well as the dollar amounts which greatly exceeded the costs of services actually performed. Livent then paid the invoices, through checks signed by Drabinsky or Gottlieb, and the vendors returned most of the money directly to Drabinsky and Gottlieb, or to Gottlieb's Canadian company, King Commodity Services Limited ("King Commodity").
Between 1990 and 1994, Drabinsky and Gottlieb received approximately $7 million through the kickback scheme, as follows. From late 1990 to early 1994, through over 90 inflated invoices, Livent paid Kofman in excess of $8 million. Of this amount, Kofman kicked-back in excess of $6 million to Drabinsky and Gottlieb, directly and through King Commodity. In addition, from February 1991 to December 1992, through approximately 9 inflated invoices, Livent paid Wayment $1 million, most of which was returned to Drabinsky and Gottlieb, directly and through King Commodity.
As a result of these kickbacks, Livent's financial statements for fiscal years 1991 and 1992 were materially false and misleading in that Livent overstated pre-tax earnings, or understated pre-tax losses, by the amounts of kickbacks paid to Drabinsky and Gottlieb in those years. For fiscal 1991, Livent reported a pre-tax loss of $1.2 million. In fact, Livent's loss in that year was approximately $4.6 million. For fiscal 1992, Livent reported pre-tax earnings of $2.9 million. In fact, the company's true earnings were approximately $100,000. Livent included these false numbers in several filings with the Commission, including the company's May 1995 registration statement, signed by Gottlieb, to register 12 million common shares, and the company's $35 million U.S. equity offering in February 1996, signed by Drabinsky and Gottlieb.
Drabinsky and Gottlieb had Eckstein improperly capitalize the payments to the vendors, approximately $4 million, into preproduction costs. As a result, Livent's fiscal 1994, 1995 and 1996 financial statements, which reported preproduction costs of $28 million, $55.4 million and $75.6 million, respectively, respectively, were overstated by at least $4 million in each year. Livent included some or all of these false numbers in numerous filings with the Commission.
D.Fraudulent Manipulation of Livent's Books and Records
In furtherance of their fraudulent scheme, from at least 1994 through the first quarter of 1998, Drabinsky and Gottlieb engaged in a deliberate manipulation of Livent's books and records. Through these manipulations, Drabinsky and Gottlieb together with other Livent officers and employees understated expenses in each fiscal quarter in order to inflate earnings. In 1996 and 1997, this scheme grew significantly in scope and magnitude due to increasing losses on various shows, including Ragtime and Show Boat. By reducing expenses on losing shows, Drabinsky and Gottlieb were able to portray the productions and the company as financially successful. This was particularly important to accomplish in quarterly periods so that Drabinsky, Gottlieb and Topol could meet the earnings and operating projections they provided to Wall Street analysts.
1.The Accounting Manipulations
Livent used three manipulative devices to carry out the accounting scheme. First, Livent transferred preproduction costs for shows to fixed asset accounts such as the construction of theaters. Preproduction costs, which include costs for advertising, sets and costumes, are incurred prior to the opening of the production. According to Livent's accounting policy, as contained in its financial statements, preproduction costs are expensed through amortization once a production begins, for a period not to exceed five years. Fixed assets, on the other hand, are depreciated over their useful life, up to forty years for buildings. As a result, Livent significantly decreased show expenses, and inflated profits, by fraudulently amortizing preproduction costs over a much longer period of time. In 1997, for example, Livent transferred preproduction costs, and certain show operating expenses, totaling $15 million from six different shows in thirty locations to three different fixed asset accounts. By this manipulation, Livent violated its own accounting policies and violated GAAP.
As a second part of this accounting scheme, at the end of each quarter, Livent simply removed certain expenses and the related liabilities from the general ledger, literally erasing them from the company's books. In the succeeding quarter, the expenses and related liabilities would be re-entered in the books as original entries. This blatant accounting manipulation violated the basic tenets of GAAP. The amount of expenses moved from current periods to future periods was internally tracked at Livent as the "Expense Roll." This manipulation permitted significant reduction in show expenses while also increasing profits. For example, the total expenses rolled from the first to the second quarter of 1997 was approximately $10 million.
Finally, Livent transferred costs from one show currently running to another show that had not yet opened or that had a longer amortization period. This accounting manipulation increased profits in a particular quarter by reducing the charge for amortization of preproduction costs, since amortization is only appropriate once a production has begun. For example, in 1996 and 1997, approximately $12 million relating to seven different shows and twenty-seven different locations was transferred to the accounts of approximately thirty-one different future locations and ten other shows then in process. This manipulation violated the company's above-stated preproduction accounting policies and violated GAAP. The amount of amortization moved from current periods to future periods was internally tracked at Livent as the "Amortization Roll."
The cumulative impact of these accounting irregularities caused Livent to materially understate expenses by $3.5 million in fiscal 1995, $18.1 million in fiscal 1996 and $8.5 million in fiscal 1997, and to overstate expenses in the first quarter of 1998 by $2.7 million.
2.Senior Management Directs the Manipulations
Former senior management orchestrated these fraudulent manipulations in the following manner. Diane Winkfein ("Winkfein") and Grant Malcolm ("Malcolm"), two senior Livent controllers, produced a general ledger showing financial results for each quarter and for year end. They provided the information to Eckstein, and, in 1997, Christopher Craib ("Craib"), another senior controller, who then put the information into an easily understood summary format for Livent's executives. Eckstein then met with Drabinsky, Gottlieb and Topol to review the results.
During these meetings, the group discussed the manipulations, and agreed on the approximate nature and quantity of adjustments to be made to the company's books, records and accounts in order to achieve a predetermined false financial picture. In general, Drabinsky directed that certain adjustments be made and Eckstein made notes of the adjustments. Eckstein then communicated the adjustments to Winkfein and Malcolm and instructed them to effect the adjustments in such a manner as to give them the appearance of original entries in Livent's accounting system, so that they could not be detected.
After the adjustments were processed, Winkfein or Malcolm provided Eckstein with an adjusted general ledger containing the accounting manipulations. Drabinsky, Gottlieb, Topol and Eckstein then met again to review the manipulated results. Drabinsky would direct any further adjustments, which Winkfein or Malcolm processed in the accounting system, at Eckstein's direction. After a final review by senior management, these bogus numbers were presented to Livent's audit committee, the auditors, investors and eventually filed with the Commission. Starting in October 1997, Messina, Livent's CFO, also began attending these subsequent meetings where the initial manipulations were reviewed, and additional manipulations were directed and agreed upon.
Because of the sheer magnitude and dollar amount of the manipulations, it became necessary for senior management to be able to track both the real and the phony numbers. At Eckstein's direction, Malcolm maintained computer files of the manipulations that tracked the details of expense capitalizations, expense rolls and show-to-show cost transfers from 1995 through the first quarter of 1998. Eckstein dictated that these records be kept, and showed them to Drabinsky to be certain that Drabinsky knew exactly what manipulations had been implemented. Tony Fiorino ("Fiorino"), the theater controller, kept track of the costs improperly transferred to theater construction accounts by creating a numerical range of accounts in the general ledger in which he recorded the transferred amounts.
In addition, commencing in approximately June 1997, Eckstein directed Craib, the senior controller of budgeting, to prepare quarterly schedules containing a comparison of actual and budgeted results. These schedules showed items such as the "expense roll" and the "amortization roll," which quantified certain of the accounting manipulations. Drabinsky, Gottlieb, Topol, Eckstein and Messina reviewed these schedules during their meetings to discuss the manipulations. And commencing in at least October 1997, Messina also prepared pre- and post-adjustment charts that reflected transferred amounts in detail, which she distributed to Drabinsky, Gottlieb, Eckstein and Topol for their meetings.
3.Falsification of Books, Records
and Accounts to Implement the Fraud
After the periodic meetings with Drabinsky, Gottlieb and Topol, Eckstein met with Winkfein and Malcolm and provided them with the approximate dollar adjustments that they were required to make to various accounts in the balance sheet and income statement, including expense categories, specific shows and fixed asset accounts. Winkfein and Malcolm, with assistance from another theater controller, then processed the adjustments.
To make the adjustments, Malcolm identified individual invoices to alter in order to achieve the overall level of adjustment specified by Eckstein. Then, on an invoice-by-invoice basis, he and Winkfein changed the distribution dates or account codes of the selected invoices, deleted the original entries from the company's computerized general ledger system, and re-posted the fraudulent information to the general ledger.
In a legitimate accounting system, these adjustments would have been made through written journal entries. However, the enormous number of bogus entries -- comprising millions of dollars in invoices -- that were necessary to comply with Drabinsky's directives required a more efficient method of adjustment. Moreover, adjusting journal entries would have left a trail of "red flags" for the auditors, something Livent's senior management did not want to create. Consequently, starting in at least 1994, Eckstein had Malcolm enlist the assistance of the manager of Livent's information services department to write a program that would enable the accounting staff to override the accounting system without a paper or transaction trail. That manager then wrote programs to enable the accounting staff to execute changes on a batch, or volume, basis. This process had the effect of falsifying the books, records and accounts of the company so completely that the adjustments appeared as original transactions, and no trace of the actual original entries remained in the company's general ledger.
4.Lying to the Auditors
Drabinsky, Gottlieb and Topol concealed, and instructed Eckstein to conceal, these accounting manipulations from the company's auditors. Winkfein and Malcolm effected this concealment by falsifying Livent's books and records. Messina also concealed this fraud from the auditors.
In connection with Livent's fiscal 1995, 1996 and 1997 year-end audits, Drabinsky and/or Gottlieb also signed management representation letters to Livent's independent auditors that were false and misleading. Each of these letters contained, in substantially similar language, the following false and misleading representations:
We acknowledge our responsibility for the fair presentation of the financial statements in accordance with generally accepted accounting principles including the appropriate disclosure of all information required by statute. . . .
The financial statements are free of material errors and omissions....
There have been no irregularities that involve management or employees who have a significant role in the system of internal controls or that could have a material effect on the financial statements. . . .
Drabinsky and Gottlieb signed a management representation letter dated March 1, 1996, in connection with Livent's fiscal 1995 year-end audit. Gottlieb signed a management representation letter dated February 24, 1997, in connection with Livent's fiscal 1996 year-end audit (the "fiscal 1996 representation letter"). And Drabinsky and Gottlieb signed a management representation letter dated April 9, 1998, in connection with Livent's fiscal 1997 year-end audit (the "fiscal 1997 representation letter").
E.Fraudulent "Revenue-Generating" Transactions
From 1996 through 1997, Drabinsky and Gottlieb orchestrated the recognition of at least $34 million in revenue by entering into side agreements on transactions that required Livent to pay back monies it received. Most of these transactions involved the sale of rights to present Livent's theatrical productions in return for specific fees paid by counter parties. Without the side agreements, the underlying sales agreements made little economic sense for the other parties: the fees were nonrefundable and the parties only obtained limited profit participation from productions which Livent had no obligation to make available for presentation.
In each case, Gottlieb or Topol negotiated side agreements that obligated Livent to repay the fees. Drabinsky, Gottlieb and other Livent officers concealed these loan arrangements from Livent's auditors. As a result, Livent recorded revenue in violation of GAAP. In total, Livent fraudulently overstated revenues in its financial statements by $16.4 million for fiscal 1996 and $17.6 million for fiscal 1997 as a result of these undisclosed side agreements.
1.Pace Theatrical Group
In 1996 and 1997, Livent sold Pace Theatrical Group, Inc. ("Pace"), a Texas-based theatrical company, the exclusive rights to present Show Boat and Ragtime in various theaters in North America for fees totaling $11.2 million (US). These agreements were contained in contracts or letters dated June 15, 1996 and August 8, 1997, with respect to Show Boat, and December 18, 1996 and August 8, 1997, with respect to Ragtime. Each of these agreements was signed, and in part negotiated, at Pace's office in New York City. In return for payment of the fees, Pace was to be reimbursed for all theater expenses to present the shows and was entitled to a limited percentage of adjusted gross ticket sales as profit participation. All of these agreements purported to make the fees nonrefundable, even if Livent never made the shows available to Pace.
On the basis of these agreements, Livent recognized as revenue in its financial statements the present value of the fees in the amounts of $1.6 million for the third quarter of 1997, $12.2 million for fiscal 1996, and $1.6 million for fiscal 1997. For purposes of the company's year-end 1996 reconciliation to U.S. GAAP, Livent deferred recognition, for reasons unrelated to the fraud described herein, of $6 million related to the sale of rights to Ragtime. Livent subsequently improperly recognized that amount in fiscal 1997.
However, Topol negotiated side letters to these agreements that granted Pace the right to recoup its fees, plus earn additional profit, as the shows were performed. These side letters were dated the same date, or days or weeks after the underlying sales agreements: the side letters for Show Boat were dated June 17, 1996 and August 20, 1997; and the side letters for Ragtime were dated December 18, 1996 and August 20, 1997. Each of these side letters was signed, and in part negotiated, at Pace's office in New York City. Although these side agreements were operative only if the shows were actually performed, the parties fully expected that Livent would make the shows available to Pace so that Pace could recoup its fees and earn a return on its investment.
In May or June 1996, during the meeting which concerned the first Pace transaction, Drabinsky directed that the side letter on Show Boat not be shown to the auditors. Thereafter, Drabinsky, Gottlieb, Topol, Eckstein, and Messina concealed the side letters on all the transactions from the auditors.
In order to support income recognition, Drabinsky, Gottlieb and Messina also affirmatively misrepresented these transactions to the auditors. Gottlieb's fiscal 1996 representation letter, which Messina also signed, falsely stated that, "We have recorded or disclosed all liabilities, both actual and contingent, and have also disclosed all guarantees that we have given to third parties." Drabinsky and Gottlieb's fiscal 1997 representation letter contained this same false and misleading statement. Drabinsky and Gottlieb also affirmatively misrepresented the transactions in another representation letter for fiscal 1996, dated July 14, 1997.
Topol also caused Pace to conceal the side letters in false and misleading confirmation letters to Livent's auditors dated July 11, 1997 and February 16, 1998, respectively, for Livent's 1996 and 1997 fiscal year audits. In fact, on or about July 15, 1997, in connection with Pace's 1996 confirmation, Topol falsely informed Pace that he had provided the two 1996 side letters to the auditors.
In 1997, pursuant to an agreement dated September 9, 1997, Livent sold American Artists Limited Inc. ("American Artists"), a Massachusetts-based theater owner and operator, the right to present Ragtime in three theaters for a fee of $4.5 million (US). The agreement made the fee nonrefundable, regardless of whether Livent made Ragtime available to American Artists. However, Topol negotiated two side letters, dated September 29 and November 15, 1997, which, together, permitted American Artists to recoup its fees in two ways: through fixed weekly amounts when the shows were performed and through "consulting fees" for the services of American Artists' president, Jon Platt. These side letters, as well as the September 9 rights agreement, were signed, and negotiated in part, in November 1997 in New York City. Drabinsky, Gottlieb, Eckstein, and Messina, who were each aware of the side agreements, concealed the side letters from the auditors. Drabinsky and Gottlieb also affirmatively misrepresented the transaction in their fiscal 1997 representation letter to the auditors. As a result, Livent fraudulently recorded approximately $5.8 million, the present value of the fee, in its financial statements for the third quarter of 1997 and fiscal 1997.
3.CIBC Wood Gundy Capital
In December 1997, Gottlieb negotiated the sale of an interest in the production rights of Show Boat and Ragtime in the United Kingdom and other countries to CIBC Wood Gundy Capital ("CIBC"), a subsidiary of the Canadian Imperial Bank of Commerce, for a fee of £2 million, or $4.6 million. In return, CIBC was entitled to certain royalty payments from the shows. The agreement also gave Livent the right until June 30, 1998 to repurchase the production rights. However, under the agreement, the fee from CIBC was non-refundable, and Livent had no obligation to stage the plays or exercise its repurchase option. Thus, CIBC assumed all risks that it would never recoup any fees or make any profit from the transaction. These terms were set out in an agreement dated December 23, 1997. Based on this agreement, Livent recorded revenue of approximately $4.6 million in its financial statements for fiscal 1997.
Gottlieb, however, negotiated two side letters with CIBC, both of which were also dated December 23, 1997. The side letters provided two mechanisms for CIBC to recoup its fees and make significant profits: if Livent exercised its repurchase option, Livent would repay all fees, plus £112,500, plus any unpaid royalties; if Livent did not exercise the repurchase option, Livent would pay CIBC an additional royalty equal to 10% of the adjusted gross weekly ticket sales of the Broadway production of Ragtime, which was expected to run for years and generate a weekly royalty of approximately $90,000 (US). Based on this arrangement, CIBC expected to earn at least a 40% return on its fees if Livent repurchased the rights, and well over 100% if it did not.
The purpose of this transaction was to provide Livent "bridge" financing until it could sell the production rights to a U.K. investor after Ragtime opened on Broadway in early 1998. Drabinsky and Gottlieb concealed the true nature of this loan and the side agreements from Livent's auditors. In fact, in or about April 1998, Drabinsky misrepresented the transaction to the auditors specifically for the purpose of showing increased operating cash flow for fiscal 1997; the auditors permitted revenue recognition, but with an offsetting expense so that there was no effect on net income. Moreover, when it became clear in early August of 1998 that Livent's new management did not know about the side agreements, Gottlieb asked the managing director of CIBC who had negotiated the transaction not to disclose the side agreements to new management so that Gottlieb could cause Livent to repurchase the rights from CIBC.
4.Dundee Realty Corporation
In 1997, Gottlieb negotiated a real estate development project with Dundee Realty Corporation ("Dundee"), a Canadian company, to enable Dundee to construct a hotel and condominium complex on land owned by Livent adjacent to the Pantages Theater in Toronto. At the time, Gottlieb served as a director of Dundee's parent, Dundee Bancorp Inc.; however, Livent failed to disclose this as a related party transaction in its fiscal 1997 annual report. Under the master agreement for the project, dated June 30, 1997, Livent and Dundee created a joint venture company and Livent sold Dundee the excess density rights over the land for $7.4 million. However, the parties entered into a separate "Put" agreement, dated August 15, 1997, that entitled Dundee to withdraw from the project and cause the joint venture, and therefore Livent, to repay Dundee's investment.
In a series of fraudulent representations to the auditors and the audit committee, Drabinsky and Gottlieb concealed the existence of the Put agreement to cause Livent to record $5.6 million in 1997, which amount was deferred for purposes of U.S. GAAP. In or about early August 1997, Gottlieb misrepresented to the auditors that the Put agreement had been canceled. He did this in an attempt to support revenue recognition in the second quarter of fiscal 1997, for inclusion in the financial statements of the company's 1997 $125 million U.S. debt offering. Gottlieb also caused Dundee's chief executive officer, Michael Cooper ("Cooper"), to confirm the cancellation of the Put agreement in a false letter dated August 27, 1997, which stated that "3ithout any compensation thereof, the put . . .was removed from the master agreement at the request of Livent Inc." What, in fact, had occurred is that Livent and Dundee simply placed the Put in an agreement separate from the master agreement, in order not to scare off potential investors and financial institutions which might have been reluctant to invest in the project knowing that one of the owners could withdraw from the venture.
In April 1998, Gottlieb again misrepresented that the Put agreement had been canceled by providing to Livent's independent auditors an April 4, 1998 letter from Dundee's chairman, Ned Goodman ("Goodman"), a long-time friend of Gottlieb. That letter stated that Gottlieb and Goodman had verbally agreed to cancel the Put agreement in August 1997. However, Gottlieb and Drabinsky concealed from the auditors another letter from them to Cooper, dated two days after Goodman's letter, which stated that, notwithstanding Goodman's letter, the Put agreement was "binding and effective and remains so in favour of 4 as if it has never been cancelled." In addition, Gottlieb and Drabinsky concealed from Livent's independent auditors a new Put agreement that Gottlieb and Cooper executed on or about May 27, 1998, which Gottlieb sent to Goodman in a May 28, 1998 letter, asking Goodman to place it "in a sealed envelope in 5 safe or safety deposit box."
Recognition of revenue from this transaction violated GAAP in two ways. First, any oral agreement to cancel the Put agreement was contingent upon Gottlieb renegotiating the joint venture agreement to ensure to Cooper's satisfaction that Dundee's rights remained secure. Thus, even if the Put agreement was canceled, recognition of revenue from the transaction would be improper because the contract was not a final, consummated sale. Second, Gottlieb and Drabinsky's April 6, 1998 letter "reinstating" the Put agreement, and the new May 27, 1998 Put, which Gottlieb entered into with Cooper, establish that Gottlieb and Drabinsky considered it to be binding on Livent. Accordingly, the existence of the Put agreement made the transaction an investment that did not qualify for revenue recognition under GAAP.
5.Dewlim Investments Limited
In 1996, Gottlieb negotiated the sale of an interest in the production rights to Show Boat in Australia and New Zealand to Dewlim Investments Limited ("Dewlim"), a British Virgin Islands company, for a $4.5 million fee. The original agreement was dated October 21, 1996, and revised by agreement dated November 3, 1997. As with the other rights sales, the sale agreement made the fee non-refundable.
However, this transaction was not a sale, but, rather, a financing, because in or about October 1996, Gottlieb and Drabinsky orally promised Dewlim's former owner, Andrew Sarlos ("Sarlos"), that Livent would repay the fee Dewlim advanced for the production rights, plus 10% interest. This arrangement is memorialized in a June 9, 1998 memo from Gottlieb to Drabinsky. It states that as "an inducement" for the Show Boat transaction, "we committed to Dewlim on behalf of Livent that Dewlim would recoup by December 31, 2000 all capital together with interest accrued monthly at the rate of 10% per annum." As a result of this concealed arrangement, Livent improperly recorded as revenue the present value of the fee, $4.2 million, in fiscal 1996; no revenue was recorded under U.S. GAAP in either of Livent's 1996 or 1997 fiscal years.
Moreover, Drabinsky and Gottlieb failed to disclose to the auditors that this was a related party transaction in two respects. First, at the time of the transaction, Sarlos was a director of Livent and chairman of Livent's audit committee. In March 1997, Gottlieb falsely denied to the auditors that Dewlim was a related party. Second, in October 1996, Gottlieb had pledged his personal Livent stock to Dewlim as security for the $4.5 million loan. Neither of these related party transactions was disclosed in Livent's annual reports for fiscal 1996 or fiscal 1997.
F.Other Fraudulent Conduct by Livent's Former Senior Management Officers and Directors
1.Materially False and Misleading Statements to Analysts
Commencing by at least the second quarter of 1995, Drabinsky, Gottlieb and Topol regularly provided false financial information to Wall Street analysts, including projections of future performance that were predicated on false data. Livent also engaged in quarterly conference calls with analysts and other interested parties, in which Drabinsky, Gottlieb and Topol were the main speakers. Drabinsky, Gottlieb and Topol made materially false and misleading representations in these conference calls concerning the company's financial results. On the basis of these representations, and the company's reported financial results, Furman Selz issued buy recommendations for Livent stock in 1997 and 1998, and Cowen & Co. issued strong buy recommendations in 1996, 1997 and 1998. Also based on the company's reported financials, PaineWebber Inc. issued buy recommendations in 1996, 1997 and 1998.
2.Livent's Fraudulent Ticket Purchases
From September 1997 through December 1997, Livent senior management arranged for Kofman and Wayment to purchase tickets for Livent's Los Angeles production of Ragtime in order to inflate ticket sales reported to Variety magazine. Aside from sheer financial cosmetics, this fraud had another very important purpose. If weekly ticket sales fell below $500,000, Livent's Los Angeles landlord, the Schubert Theater, could evict the company pursuant to a clause in their lease contract. Since Livent planned to open Ragtime on Broadway in January 1998, poor sales in Los Angeles would have undermined its planned opening, and an eviction would have been devastating. Since management was counting on Ragtime to turn the financial fortunes of the company around, it was imperative to portray the Los Angeles production of Ragtime as financially successful.
From September 30, 1997 to December 31, 1997, Kofman purchased tickets totaling $381,015 (US) from the box office at the Schubert Theater in Los Angeles. Livent made these purchases using Kofman's personal credit card or through checks issued by Kofman from one of his companies. Livent then reimbursed Kofman or his companies. In November 1997, Eckstein also enlisted Wayment to purchase tickets to the Los Angeles production of Ragtime. Eckstein instructed Wayment to write checks to the Schubert Theater for tickets. Livent then reimbursed Wayment's construction company, Execway.
Eckstein directed the Livent accounting staff to improperly capitalize these ticket purchases in Livent's fixed asset accounts. As a result, Livent's fixed asset accounts were false and misleading. Moreover, the box office numbers reported by Livent to Variety were materially false and misleading, designed to convey the false impression that Ragtime was a successful engagement in Los Angeles, when, in fact, it was not.
G.False Public Filings
On or about May 4, 1995, Livent filed with the Commission a registration statement on Form 20-F, signed by Gottlieb, to register 12 million common shares in the United States. On or about June 28 and July 31, 1995, Livent filed with the Commission amendments to the registration statement, signed by Gottlieb, on Forms 20-F/A. The registration statement, and the amendments, contained disclosures and financial statements for the years ended December 31, 1991, 1992 and 1994, which were materially false and misleading. For fiscal 1991, Livent reported a pre-tax loss of $1.2 million. In fact, Livent's loss in that year was approximately $4.6 million. For fiscal 1992, Livent reported pre-tax earnings of $2.9 million. In fact, the company's true earnings were approximately $100,000. In addition, for fiscal 1994, Livent reported preproduction costs of $28 million, which amount was overstated by approximately $4 million. Livent's true preproduction costs in fiscal 1994 were approximately $24 million.
On or about February 12, 1996, Livent filed with the Commission a registration statement on Form F-1, signed by Drabinsky, Gottlieb, Topol and Eckstein, to register 3.75 million common shares in the United States at an aggregate offering price of approximately $35 million (US). On or about March 6 and March 25, 1996, Livent filed with the Commission amendments to the registration statement, signed by Drabinsky, Gottlieb, Topol and Eckstein, on Forms F-1/A. On or about March 29, 1996, Livent filed with the Commission the prospectus for its offering. The registration statement, the amendments and the prospectus contained disclosures and financial statements for the years ended December 31, 1991, 1992 and 1994, which were materially false and misleading, as described above.
On or about June 21, 1996, Livent filed with the Commission its fiscal 1995 annual report on Form 20-F. The annual report contained disclosures and financial statements for the years ended December 31, 1994 and 1995, which were materially false and misleading. For fiscal 1995, Livent reported pre-tax earnings of approximately $18.2 million, which was overstated by approximately $3.5 million. Thus, the company's true earnings in that year were approximately $15 million. In addition, Livent's preproduction costs for fiscal 1994 were inflated as described above. For fiscal 1995, Livent reported preproduction costs of $55.4 million, which was overstated by approximately $4 million.
On or about May 30, 1997, Livent filed with the Commission its quarterly report on Form 6-K for the period ended March 31, 1997. The report, signed by Gottlieb, contained disclosures and unaudited financial statements for the three months ended March 31, 1997, which were materially false and misleading in that Livent reported pre-tax earnings of $6.4 million which were inflated by at least $6.2 million. In fact, the company's earnings for that year were approximately $200,000.
On or about July 15, 1997, Livent filed with the Commission its fiscal 1996 annual report on Form 20-F. The annual report, signed by Gottlieb, contained disclosures and financial statements for the years ended December 31, 1994, 1995 and 1996 that were materially false and misleading. For fiscal 1995, the company reported inflated pre-tax earnings as described above. For fiscal 1996, Livent reported pre-tax earnings of approximately $14.2 million, which was overstated by at least $34.5 million. In fact, the company had incurred a loss in fiscal 1996 of at least $20 million. In addition, Livent reported inflated preproduction costs for fiscal 1995, as described above. For fiscal 1996, Livent reported preproduction costs of $75.6 million, which was also overstated by approximately $4 million. Further, for fiscal 1996, Livent reported fixed assets of approximately $133.2 million, which was overstated by at least $6 million. Thus, the company's true fixed assets in fiscal 1996 were not more than $127 million.Thus, the company's true fixed assets in fiscal 1996 were not more that $127 million.
On or about September 8, 1997, Livent filed with the Commission its quarterly report on Form 6-K for the period ended June 30, 1997. The report, signed by Gottlieb, contained disclosures and unaudited financial statements for the six months ended June 30, 1997, which were materially false and misleading in that Livent reported pre-tax earnings of $1 million that were inflated by at least $14.9 million. In fact, the company had incurred a loss in the second quarter of 1997 of more than $13.8 million.
On or about November 6, 1997, Livent filed with the Commission a registration statement on Form F-4, signed by Drabinsky, Gottlieb, Topol and Messina, to register a $125 million (US) debt offering. On or about November 18, 1997, Livent filed with the Commission an amendment to the registration statement, signed by Drabinsky, Gottlieb, and Messina, on Form F-4/A. On or about December 10, 1997, Livent filed with the Commission the prospectus for its offering. Each of these filings contained disclosures and financial statements for the years ended December 31, 1994, 1995 and 1996, which were materially false and misleading, as described above.
On or about December 1, 1997, Livent filed with the Commission its quarterly report on Form 6-K for the period ended September 30, 1997. The report, signed by Gottlieb, contained disclosures and unaudited financial statements for the nine months ended September 30, 1997, which were materially false and misleading in that Livent reported pre-tax earnings of $5.9 million that were inflated by at least $19.8 million. Thus, the company actually had incurred a loss in the third quarter of 1997 of more than $13.9 million.
On or about June 2, 1998, Livent filed with the Commission its quarterly report on Form 6-K for the period ended March 31, 1998. The report, signed by Gottlieb, contained disclosures and unaudited financial statements for the three months ended March 31, 1998, which reflected a continuation of the accounting irregularities.
On or about June 30, 1998, Livent filed with the Commission its fiscal 1997 annual report on Form 40-F. The annual report contained disclosures and financial statements for the years ended December 31, 1995, 1996 and 1997 which were materially false and misleading. Livent reported inflated earnings for fiscal 1995 and 1996, and inflated preproduction costs and fixed assets for fiscal 1996, as described above. For fiscal 1997, Livent reported a pre-tax loss of approximately $62.1 million, which was understated by at least $21.4 million. In fact, the company's loss for fiscal 1997 was approximately $83.6 million. In addition, for fiscal 1997, Livent reported fixed assets of approximately $200.8 million, which was overstated by approximately $23.9 million.company's true fixed assets in fiscal 1997 were not more that $176.1 million.
H.New Management Takes Over Livent
The arrival of new management merely emboldened Drabinsky and Gottlieb. The two continued to manipulate the company's financial statements and instructed their staff to generate two versions of financial schedules -- one, designed for Drabinsky and Gottlieb, which included the description of improper cost transfers, and a second, designed for new management, which did not provide the description of improper cost transfers. Drabinsky instructed Messina and Eckstein not to give the more illustrative schedules to new management. Livent's accounting staff concealed the fraud from new management.
On August 5, 1998, Livent's new senior management discovered the existence of the CIBC side letter described above. On August 6, 1998, Livent's new senior management became aware of serious accounting irregularities affecting the company's financial statements for the fiscal years ending December 31, 1996 and 1997, and the first quarter of 1998. On August 7 and 8, 1998, Livent's new senior management investigated these irregularities and, on Sunday, August 9, 1998, briefed the company's directors on their discoveries. On Monday, August 10, 1998, Livent publicly announced the discovery of serious accounting irregularities at the company, alerted the SEC, the Ontario Securities Commission, NASDAQ and the Toronto Stock Exchange to the discovery of the irregularities and suspended Drabinsky and Gottlieb pending completion of an internal investigation. Livent issued restated financial statements on November 18, 1998.
As described above, Livent engaged in an accounting fraud that spanned eight years and resulted in materially false and misleading financial statements and disclosures filed with the Commission and disseminated to investors. Livent also maintained false and misleading books, records and accounts, including false records concerning the value of its preproduction costs, fixed asset accounts, revenues and expenses. Livent failed to maintain a system of internal accounting controls sufficient to permit preparation of the company's financial statements in conformity with GAAP. In fact, former management intentionally circumvented the company's internal accounting controls by, among other things, overriding the company's computerized accounting system. This absence of adequate internal controls directly contributed to the fraud. As a result of the conduct outlined above, the company's 1995, 1996 and 1997 annual and other reports were all materially misstated. Accordingly, Livent violated Section 17(a) of the Securities Act, Sections 10(b), 13(a), and 13(b) of the Exchange Act, and Rules 10b-5, 12b-20, 13a-1, 13a-16 and 13b2-1 promulgated thereunder.
Based on the foregoing, the Commission finds that Livent committed violations of Section 17(a) of the Securities Act, Sections 10(b), 13(a), and 13(b) of the Exchange Act, and Rules 10b-5, 12b-20, 13a-1, 13a-16 and 13b2-1 promulgated thereunder.
Based on the foregoing, the Commission deems it appropriate and in the public interest to accept Livent's Offer and impose the sanctions agreed to therein.
Accordingly, IT IS HEREBY ORDERED that:
Pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, Livent cease and desist from committing or causing any violation and any future violation of Section 17(a) of the Securities Act, Sections 10(b), 13(a), and 13(b) of the Exchange Act, and Rules 10b-5, 12b-20, 13a-1, 13a-16 and 13b2-1 promulgated thereunder.
IT IS FURTHER ORDERED that Livent comply with its undertaking to: upon reasonable request by the Commission or its staff, and on reasonable notice, and without service of a subpoena, it will provide documents or other information, and accept service and take all reasonable actions to make its officers, directors, employees and agents available to testify truthfully at any interview, investigative testimony, deposition, at any judicial proceeding related to this Order, and at any administrative proceeding arising as a result of the Commission's investigation entitled In the Matter of Livent Inc. This provision shall not be construed to waive applicable attorney-client, work product or other privileges recognized under federal law of Livent and its officers, directors, employees and agents, if asserted timely and in good faith.
By the Commission
Jonathan G. Katz
|1||The Commission's findings herein are made pursuant to the Offer and are not binding upon any other person or entity in these or any other proceedings.|
|2||Canadian dollars will be used in this Order unless otherwise indicated. The current exchange rate is $.65. Thus, the adverse effect on net income in current U.S. dollars was $63.7 million.|