Livent’s auditors ignored ‘red flags,’ court told

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Livent Inc.'s auditors at Deloitte & Touche ignored "red flags" of fraud and were negligent in their reviews of the company's financial statements, a Toronto court heard Monday.

A long-delayed $450-million lawsuit against Deloitte began Monday, 15 years after the live theatre company collapsed amid allegations of fraud. The lawsuit was filed against the audit firm by Livent's special receiver on behalf of the company's creditors and shareholders.

Livent lawyer Peter Howard told Ontario Superior Court Justice Arthur Gans that auditors knew they had been lied to on a number of occasions by management at Livent, and therefore should have been far more suspicious and probing when reviewing the company's books and approving key business transactions.

"There were plenty of red flags to indicate the potential for a fraudulent manipulation," Mr. Howard said in his opening remarks at the trial.

Mr. Howard said the people working on the audit at Deloitte changed frequently and failed to pass along information about known "risks" of relying on statements of information from company founders Garth Drabinsky and Myron Gottlieb.

Mr. Drabinsky and Mr. Gottlieb were found guilty in 2009 of orchestrating a fraud that saw Livent's financial statements misstated every quarter from 1993 to 1998. They were sentenced to five years and four years in prison respectively, but have since been released on bail.

Livent alleges Deloitte & Touche's errors on its audit began when Livent's predecessor was founded in 1989 and expanded "exponentially" after the company became publicly traded in 1993, Mr. Howard said.

"If you add to what they knew what they ought to have known, they couldn't sign a clean (audit) opinion," Mr. Howard argued.

He said the trial will hear that one of Deloitte's audit partners complained internally in 1998 that he had been lied to three times by Livent officials and even suggested Deloitte should quit the audit.

But that audit partner did not know of other problems and other lies from earlier years, Mr. Howard said. He said such knowledge might have made him far more suspicious and led to a deeper review of Livent's books.

"There was no continuity in terms of the partners and the senior managers over the years," Mr. Howard said. "In the last five years there were at least four and possibly five separate engagement partners."

Deloitte had an internal handbook with standards for documenting and sharing information about known risks related to an audit file, "and we will say they were all breached," he added.

Mr. Howard concluded his opening remarks Monday and Deloitte lawyer John Lorn McDougall is expected to make his opening comments on Wednesday or Thursday.

In a written copy of his opening statement filed with the court, Mr. McDougall argues Livent has no authority to launch a lawsuit against Deloitte because Livent was responsible for committing the fraud through its most senior executives.

"This case is about a corporation that purposely deceived its auditor in order to perpetrate a fraud, and which is now suing the auditor for not seeing through its lies and deception," he said.

The audit work done by the firm met professional standards in place in the 1990s, and could not have detected a fraud that so many people were trying to hide, including multiple levels of Livent managers, Mr. McDougall said.

He said Livent also has no authority to sue on behalf of creditors and shareholders for their losses, saying such a claim goes against basic principles of corporate law. Livent itself also cannot claim losses, Deloitte adds, because the company was assisted and not harmed by the auditor's inability to detect its fraud.

The lawsuit will be closely watched in business circles because there has been legal uncertainty about when – if ever – auditors can be held responsible for failing to detect an accounting fraud at a public company.

Shareholders in Canada have faced difficulties suing auditors since a 1997 Supreme Court of Canada decision set out narrow parameters for a successful lawsuit.