In late September, the longest Institute of Chartered Accountants of Ontario (ICAO) disciplinary hearing – more than 37 months – finally ended. But now it is heading into overtime.
Deloitte & Touche LLP recently filed an appeal to re-examine the ICAO discipline committee decision against three of its Toronto-based partners.
The decision included two findings of professional misconduct against Anthony Power and Claudio Russo and one finding of professional misconduct against Douglas Barrington for failing to perform professional services during their audit of Livent Inc.’s 1997 financial statements. Charges against a fourth partner, Peter Chant, were dropped.
On September 27, the committee announced that each of the guilty partners would receive a written reprimand, a fine of $100,000 and be required to pay costs of $417,000. If the charges stand up on appeal, Deloitte has agreed to pay on behalf of its partners. Barrington and Power have both reached the firm’s retirement age; Russo and Chant remain active with Deloitte.
“It’s clear why Deloitte is appealing,” says Karim Jamal, Edmonton-based accounting professor at the University of Alberta.
“There’s an awful lot at stake – the reputation of a very large accounting firm, not to mention those of three of its partners.”
Jamal believes that Deloitte may face a daunting challenge in its appeal. “ICAO has done a very professional and thorough job laying out its case,” he says. “It took the time and brought in the necessary resources to put together a comprehensive report supporting the reasons for its decision.
“It also sends out a clear message to its critics, who claim that it only goes after smaller firms. By pursuing Deloitte, ICAO is demonstrating its willingness to pursue wrongdoing wherever it finds it.”
For both sides, it has been a long and expensive haul. On March 12, 2004, ICAO served the charges on the Deloitte partners. On January 11, 2005, the disciplinary panel convened its first session.
The panel’s 72-page decision was released on February 11, 2007 and subsequently a 26-page reasons document was published last September 27. Those two highly detailed briefs are the distillation of countless pages of hearing transcripts, not to mention accounting records, meeting minutes, memos, e-mails, and other relevant communications within Deloitte, as well as between Deloitte and Livent, a prominent live theatre production company.
In addition, under the rules in force at the time, ICAO could only sue individuals rather than firms, so each of the accused members was represented by his own counsel and sometimes by a team of lawyers. For its part, the ICAO panel received support from two outside investigator/experts and a coterie of legal help. In fact, the ICAO lawyers spent 2,138 billable hours – more than a person-year of legal work at $350 per hour – on the case. The costs for Deloitte are not publicly known.
The accounting institute declined comment on the case since it is under appeal. Barrington, Power, Russo and Chant were not made available for responses.
As background, in 1998 after the 1997 audit was completed and filed, new owners took over Livent and soon discovered information that led to ICAO charges of misconduct against Livent senior management and its internal accounting staff. Later that year, Livent sought bankruptcy protection in both Canada and the U.S. and eventually the firm was dissolved.
In 2000 two Livent senior financial officers, Maria Messina and Gordon Eckstein, were found guilty by ICAO of fraud-related charges, and failure to maintain the reputation of the profession. Former Livent vice-chair Garth Drabinsky and vice-president Myron Gottlieb still face criminal charges in Ontario.
“The whole case boils down to two issues,” says Bruce Jenkins, Toronto-based deputy chief executive, Deloitte & Touche LLP. “The first is, ‘Was the result of the audit in accordance with what the profession would expect?’ We are saying, ‘Was the accounting acceptable as opposed to was it right or wrong?’ We believe the accounting was OK. The panel’s experts believed the accounting was acceptable. What the panel seems to be looking for was, ‘Was it correct?’
“The second is ‘What constitutes professional misconduct?’ Is the fact that you did not get it right professional misconduct? We do not believe so. We don’t believe there is a right or wrong answer regarding accounting.
“The fraud involved the manipulation of Livent’s accounting and computer records,” says Jenkins, “particularly to make their shows looked differently than they actually were in terms of their profitability. But such manipulation had nothing to do with the way we handled the four accounting transactions we audited.”
Deloitte’s position is not new. In its announcement, the ICAO discipline committee stated: “This is a standards case, not a case alleging that the members should have detected fraud. Professional misconduct alleged against the members did not include moral turpitude. There was no suggestion that the members actually knew about the fraud.”
At the heart of Deloitte’s position is its insistence that it followed standard accounting practices while performing the Livent audit. “We considered this engagement as high risk,” says Jenkins, “We had a number of partners involved and had a lot of consultation. We all knew this thing was a major challenge.
“We spent a lot of time consulting, a lot of time debating and a lot of time arguing to be able to say, ‘we got it right’ because the consequences of getting it wrong are so significant. We believed we had sufficient evidence to support our opinion.”
The panel concluded, “It is not sufficient for auditors to identify the risk and make appropriate plans to deal with them. The audit must be properly executed.”
The 1998 collapse of Livent created shockwaves throughout the Canadian and U.S. financial markets.
An Ontario Securities Commission (OSC) press release dated Nov. 19, 1998 summarizes Livent’s downfall: “On Aug. 10, 1998 Livent issued a press release disclosing that an internal investigation had revealed serious irregularities in the company’s financial records. The problems were uncovered by members of the company’s new senior management team in preparing the company’s June 30, 1998 interim report. The company disclosed that the irregularities involved improper recognition of revenue and the failure to record, or the improper deferral and capitalization of expenses.
“The company disclosed that it was too early to determine the precise amount or effect of the irregularities but that they appeared to involve millions of dollars. The company also disclosed that it seemed virtually certain that the company’s financial results for 1996, 1997 and the first quarter of 1998 would need to be restated as a result of the irregularities.”
The OSC release further states: “On Nov. 18, 1998, Livent issued a press release disclosing its restated financial results for 1996, 1997 and the first quarter ended March 31, 1998. The restated results reduce previously reported net income for these periods in an aggregate amount of $85.1 million. Livent also disclosed its financial results for the second quarter ended June 30, 1998, reporting a net loss of $45.8 million, including a writedown of assets and other charges of $26.1 million.
“In addition, Livent disclosed that it had filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code and was considering appropriate protective action in Canada; that its board of directors had voted to terminate Garth Drabinsky, vice-chairman and chief creative director and Myron Gottlieb, executive vice-president, Canadian administration, effective immediately.”
At the time, an RCMP spokesperson stated, “We estimate that approximately $210 million in market capitalization was lost between the time the trading of Livent shares halted on Aug. 10, 1998, and when trading resumed on Nov. 19, 1998.”
When Livent sought bankruptcy protection, there were 30 or so unsecured creditors, including Deloitte. As a result, it never received payment for its estimated $95,000 audit fee.
A long series of criminal, civil and regulatory investigations ensued involving a New York State grand jury, the U.S. Securities and Exchange Commission, the RCMP, the OSC and ICAO. Deloitte has never been charged in any of the fraud-related probes.
Criminal charges against Drabinsky and Gottlieb are scheduled to be heard in Ontario in 2008. After that is settled, the two executives will face OSC hearings.
Since the ICAO investigation was focused solely on accounting standards, neither Drabinsky nor Gottlieb were a party to it.
However, ICAO was active earlier in dealing with Livent’s internal accounting team. On March 30, 2000, it fined Livent’s chief financial officer, Messina, $7,500 and suspended her for two years after finding her guilty of two charges of failing to maintain the good reputation of the profession and serve the public interest, and one charge of signing a statement which she knew to be misleading.
On June 1, 2000, ICAO found Eckstein, Livent’s former vice-president of finance and administration, guilty of two charges of failing to maintain the good reputation of the profession and its ability to serve the public interest, and one of signing or associating himself with statements which he knew were misleading. Eckstein was fined $25,000 and expelled from the institute.
Currently Deloitte is waiting for overtime to begin after ICAO checks its calendar and sets an appeal hearing date in 2008.