Top court finds auditor liable for failing to detect white-collar crime

Auditing firm Deloitte must pay $40 million in damages to a Canadian broadway musical company whose founders perpetrated a fraud that the auditor failed to detect, the Supreme Court of Canada ruled in a divided decision released Wednesday.

Canada’s highest court allowed – in part – Deloitte’s appeal of a Ontario Appeal Court decision. That ruling was characterized by Deloitte as a finding that a corporation should “effectively be indemnified by its auditor for the disproportionate losses suffered by stakeholders.”

Livent produced Phantom of the Opera and Joseph and the Amazing Technicolor Dreamcoat, among other shows. Livent successfully sued Deloitte after it went into receivership in 1999. Garth Drabinsky and Myron Gottlieb were sent to jail for fraud and forgery in 2009, 20 years after founding Livent and 11 years after being fired by new management.

Livent’s receiver filed its lawsuit against Deloitte in 2002. Deloitte argued at trial in 2013 that Livent’s losses were caused by Livent’s own illegal acts.

But in 2014, Justice Arthur Gans of the Ontario Superior Court of Justice awarded Livent $84.75 million ($118 million including interest), finding that Deloitte failed to meet its professional standard of care as an accounting firm. The Supreme Court of Canada knocked the damages down to $40 million in its Dec. 20, 2017 ruling, but reiterated the liability of the auditor.

“Certain activities — like flying commercial aircraft, manufacturing pharmaceutical drugs, or auditing a large corporation — may well give rise to significant liability,” Supreme Court of Canada Justices Clement Gascon and Russell Brown wrote on behalf of the majority.

Chartered Professional Accountants of Canada, which intervened on behalf of Deloitte, argued in its factum that Canadian courts have “guarded against indeterminate liability” for accountants, adding that expanding liability of auditors for firms in financial distress would have consequences.

“A liability regime is likely to emerge whereby auditors would become a de facto insurer, or guarantor, for the losses of a corporation’s stakeholders when the corporation cannot make them whole,” CPAC argued.

But liability “arises from the nature of the defendant’s undertakings and of the severe but reasonably foreseeable scale of injury that can result where such undertakings are negligently performed,” Justices Clement Gascon and Brown wrote for the court. “This explains the significant compensation which these high risk undertakings typically attract. It also explains why contractual disclaimers limiting liability may often be warranted.”

Court records indicate that Deloitte’s liability insurance covers the full amount of the original trial award.

In 1998, Livent restated its financial results for 1996 and 1997. Several accounting irregularities and frauds occurred during the 1990s. As outlined in the court decision in Drabinsky and Gottlieb’s criminal trial, these irregularities included: “deferring operating costs from the accounting period in which they were actually incurred to future accounting periods, transferring expenses properly associated with one project to another project, and improperly transferring operating and preproduction costs to fixed asset accounts relating to theatre construction.”