Canada's largest shareholder coalition is urging the Supreme Court of Canada to send a message to the accounting profession that auditors must not allow themselves to be "pushed around" by management.
The Canadian Coalition for Good Governance (CCGG), which represents most of Canada's largest institutional investors, is intervening in a Supreme Court hearing scheduled for Feb. 15 into the long-running legal dispute between Livent Inc. and its former audit firm Deloitte LLP.
The failed theatre company, represented by its special receiver, is suing Deloitte for negligence, arguing the auditors overlooked warning signs prior to the firm's collapse in 1998, particularly in Livent's controversial 1997 financial results.
The Ontario Superior Court ruled in 2014 that Deloitte ignored red flags about problems at Livent, and imposed damages totalling over $130-million with interest. The Ontario Court of Appeal upheld the decision in early 2016. Deloitte has appealed further to the Supreme Court.
In written arguments filed in advance of the Supreme Court hearing, the CCGG said the lower court ruling should be upheld because it "sends a message that auditors should not be pushed around." The coalition said it is well known that auditors can face pressure and threats from management when they raise concerns, but they will be more likely to hold firm if they know they face legal risks.
"If auditors cannot be held to account in the extraordinary circumstances of this case, it is difficult to imagine a case in which auditors would be held liable," the CCGG said. "If auditors can avoid liability here, no economically rational auditor would resist management pressure."
The CCGG got involved in the case because it will determine important issues about the responsibilities of auditors who work on behalf of shareholders, said coalition chair Julie Cays.
"Someone needs to provide to the court the perspective of the shareholders on the role and value of the audit of public companies, and the role of auditors in Canadian capital markets," she said.
The case is also being closely watched by many within the accounting industry, who are worried the court's decision could lead to many more lawsuits against auditors whenever fraud occurs at a company.
Chartered Professional Accountants of Canada, a national organization for the accounting profession, is another intervenor in the case, warning the court's decision could risk exposing auditors to "indeterminate liability" for wrongdoing. It could have a chilling effect on the audit profession and jeopardize the availability and affordability of audit services, CPA Canada said.
"Accounting firms will likely avoid higher-risk audit clients, particularly in higher-risk industry, who are often the most in need of audit services to generate growth," the association said.
Livent collapsed in 1998 after new owners raised concerns about accounting improprieties. Company founders Garth Drabinsky and Myron Gottlieb were convicted of fraud and sentenced to jail terms in 2009. Both have since been released.
The legal case against Deloitte is considered pivotal because it has been almost impossible for investors to sue auditors when they fail to detect or stop fraud. A Supreme Court decision in 1997 involving Hercules Management Ltd. set out very narrow parameters for lawsuits against auditors, concluding auditors owe their duty of care to the corporation that hires them, and not to shareholders or creditors directly.
Because of that ruling, the lawsuit against Deloitte was filed by Livent itself through its special receiver, even though a creditor group has led and financed the litigation and will receive much of the award.
Deloitte argues investors "simply dressed up their claims in the guise of corporate losses at Livent" to fit within the parameters of the Hercules ruling, saying the case is not truly a claim from Livent, which is only a "nominal plaintiff."
Deloitte also said the fraud at Livent was directed by the company's top executives, which essentially means the company itself conducted the fraud or is "vicariously responsible" for the misconduct of its employees, and should not be allowed to sue for damage caused by its own acts.
Livent, however, said in its court filing that managers by definition conduct an accounting fraud, and auditors cannot be given a complete defence for negligence because of that.
"The fact that there turns out to have been fraud should not excuse the auditor for failing to detect it – or why bother retaining the auditor in the first place?" Livent said.