Strategy

Livent: Whodunit

Did Livent’s Garth Drabinsky and Myron Gottlieb defraud investors, or were they framed by corrupt employees?

Garth Drabinsky and Myron Gottlieb appeared calm and confident way back in May as they waited for the first witness to testify in their long-delayed fraud trial. Before the day’s proceedings began, Gottlieb walked to the wooden court benches behind the three Crown lawyers and struck up a brief, pleasant but somewhat awkward conversation with a woman. The exchange could have been between two old friends catching up after a chance meeting. But Gottlieb and Drabinsky — the impresarios behind such lavish Broadway-style musicals as The Phantom of the Opera and Kiss of the Spider Woman — were facing two criminal fraud charges and another charge of uttering forged documents that could send both men to prison for up to 10 years. And the woman Gottlieb was chatting with was no mere acquaintance. She was the wife of Peter Kofman — an engineer who helped design and build Livent Inc.’s impressive theatres in Toronto, Chicago and New York, and the first witness for the prosecution.

Kofman would soon testify about how Gottlieb ordered him to submit bogus construction invoices to Livent as part of a “kickback” scheme that prosecutors say diverted millions of company funds into the pockets of Drabinsky and Gottlieb. It was the first of many improper accounting manoeuvres the two executives used to manipulate Livent’s financial records in what prosecutors allege amounts to a $500-million fraud.

As the trial continued, Gottlieb gave just about every witness a courteous “good morning” when they passed in the courtroom hallway. That included Gordon Eckstein — Livent’s former senior vice-president of finance and administration, and the man defence lawyers called a “rogue and a liar” and the true mastermind behind the alleged fraud at the once high-flying theatre company. Even Maria Messina, Livent’s former CFO who blew the whistle on the fraud and whom defence lawyers accused of orchestrating a complex and intricate conspiracy to frame the Livent founders, received the same friendly greeting.

That conspiracy includes just about all of the prosecution witnesses, the defence argued. From the senior Livent executives who testified about attending meetings where Drabinsky and Gottlieb routinely discussed plans to manipulate the company’s finances, to junior accountants who implemented the myriad accounting shenanigans and had their own encounters with the executives that seemed to indicate they knew exactly what was going on. “The prosecution must rely upon disreputable witnesses whose testimony is suspect and must be viewed with extreme caution,” Brian Greenspan, the lawyer representing Gottlieb, said in written arguments filed in December. “They are the admitted participants in a fraud who had a ‘stake in the prosecution’…. It is difficult to conceive of a greater incentive to falsely attribute responsibility to Mr. Gottlieb [and Drabinsky] than the motive to shift blame.”

Prosecutors Robert Hubbard, Alex Hrybinsky and Amanda Rubaszek mocked those claims as “preposterous” and said the evidence presented at trial is overwhelming. “It is impossible to deny that a fraud took place at Livent,” prosecutors said in their own final written arguments. “Given their positions at Livent, it is implausible that the accused were unaware of the financial state of the company.” Prosecutors produced dozens of reports, memos and executive summaries that allegedly showed how millions of dollars in expenses were improperly rolled to future periods or buried in the company’s balance sheet. These manipulations were clearly summarized and highlighted on reports that often contain handwritten notes from Gottlieb or Drabinsky. “They are impossible to miss and would be obvious even to the most indolent CEO,” the Crown maintained. “It is inconceivable that these major reallocations could have escaped the attention of the senior executives.”

Ultimately, it is up to Ontario Superior Court Judge Mary Lou Benotto, who oversaw the case without a jury, to decide whose version of events at Livent she believes. Will she conclude that Drabinsky, 59, and Gottlieb, 65, were the architects of one of the most infamous corporate frauds in Canadian history? Or will she side with the defence and rule that the prosecution witnesses lied to investigators, police and an army of civil lawyers in an effort to frame the executives for crimes they did not commit?

Count 1: The proper accounting of kickbacks

The alleged fraud at Livent began when the firm was little more than a private partnership whose only shareholders were Drabinsky and Gottlieb, prosecutors say. The pair founded MyGar Partnership in late 1989, shortly after they were ousted from their positions at Cineplex Odeon Corp. after a nasty public battle with MCA, the U.S. film studio that owned 49% of Cineplex stock at the time.

As part of their exit package, Drabinsky and Gottlieb negotiated to purchase the rights to The Phantom of the Opera and ownership of Toronto’s Pantages Theatre from Cineplex. The two men borrowed up to $60 million from the Royal Bank but still needed millions more to finance their personal stake in the deal. In an effort to circumvent restrictions imposed by RBC on how much money Drabinsky and Gottlieb could take out of the company, Gottlieb came up with a “kickback” scheme to divert Livent funds to the executives, prosecutors allege.

Sometime in 1991, Gottlieb ordered Peter Kofman (and another construction supplier) to pay him and Drabinsky for business introductions and other services that were never performed, Kofman testified. Gottlieb told him those expenses would be reimbursed when Kofman submitted false invoices of his own for work that wasn’t done, either. Between 1991 and 1994, MyGar paid Kofman over $8.3 million, but more than $5.8 million of that was redirected back to Drabinsky and Gottlieb, according to a 1994 memo Kofman wrote to Drabinsky.

Testifying was clearly difficult for Kofman: the engineer had worked with Drabinsky since 1983 when he joined Cineplex as part of that company’s in-house architectural-engineering department, the two men vacationed together, and in his autobiography, Closer to the Sun, Drabinsky described Kofman as his “younger brother.” The engineer’s impressive work with Livent should have brought him great acclaim, but instead his association with the alleged fraud left his reputation in tatters, cost him thousands of dollars and made it nearly impossible for him and his staff to find work. “I can’t bear to think about how much all of this cost me,” Kofman told the court.

Neither Drabinsky’s nor Gottlieb’s lawyers disputed that their clients participated in the scheme, but claimed all the money funnelled through the construction companies went to business-related expenses. And since MyGar was a private company at the time, all those bogus invoices flying back and forth aren’t necessarily fraud. However, prosecutors argued, it was fraud to include those false invoices in the financial statements Livent filed with securities regulators as part of its application to become a publicly traded company.

Drabinsky and Gottlieb had no idea how the payments were accounted for on the company’s books and relied on Eckstein to ensure the transactions were properly booked, the defence said. But that’s impossible, argued Crown prosecutor Hrybinsky, since only Gottlieb and Drabinsky knew the true nature of the bogus invoices. “Eckstein would have had to have the scheme explained to him,” Hrybinsky said. “There is no evidence the accused told him to do anything different.” Either way it begs the question: is there any proper way to account for fraudulent kickbacks?

The defence seemed to have more luck convincing Judge Benotto that no shareholders were harmed by the inclusion of the false invoices on Livent’s balance sheet, since the company was actually undervalued at the time of the IPO. During final arguments, Benotto asked Hrybinsky about the defence contention that the Pantages Theatre, which was valued at about $56 million in the company’s prospectus, was actually worth as much as $75 million according to a valuation done earlier. “Publicly filed documents are supposed to be truthful. In this case, they were deliberately untruthful,” Hrybinsky told the court. “You can’t say there are false bookings on our balance sheet, but that’s okay because they are more than offset by this theatre value, so there is no need to tell anyone.”

Count 2: When “actual” doesn’t actually mean “actual”

The alleged fraudulent manipulations to Livent’s books increased after the company went public. Livent may have been reporting profits almost every financial quarter, but behind the scenes Drabinsky, Gottlieb and former chief operating officer Robert Topol were directing Eckstein to push millions of dollars in company expenses to future periods, transfer costs to different shows or bury the expenses in the company’s fixed assets, Eckstein testified. (Topol was fired in 1998 after he misappropriated about $240,000 worth of Livent shares. He was later charged in the Livent fraud case, but those charges were dropped in 2007 after a judge cited the excessive trial delays associated with the case.)

Those manipulations continued unabated until 1998 when Livent announced a massive $27.5-million writedown of production costs as part of a deal with Hollywood mogul Michael Ovitz. In April 1998, Ovitz, the one-time head of Creative Artists Agency, announced a deal with Drabinsky and Gottlieb in which he would buy a controlling stake in Livent and install his own financial managers. In August 1998, just six weeks after Ovitz took control of the company, Messina blew the whistle, and Drabinsky and Gottlieb were suspended. The events surrounding the Ovitz transaction and Messina’s role as whistle-blower were the subject of intense and often brutal cross-examination by defence lawyers.

Neither Drabinsky nor Gottlieb had the accounting training or the time to closely monitor the company’s finances, the defence maintained. Gottlieb had only a “macro” understanding of Livent and was “out of the loop” when it came to the inner-workings of the company he helped found. Gottlieb did not attend production or advertising meetings and was notorious for actually falling asleep during the meetings he did attend, Brian Greenspan suggested during the trial. “The business and corporate records of Livent provide a clear testament to the contributions [of Gottlieb],” Greenspan argued. “At the same time, they provide an equally clear insight into Mr. Gottlieb’s lack of knowledge and participation in the operation of Livent’s core business.”

Drabinsky was not paying close attention to the books, either, according to the defence. He spent much of his time on the road overseeing the launch of new Broadway shows or tracking the progress of other shows travelling throughout North America, argued David Roebuck, a civil lawyer who also represented Drabinsky in criminal and civil Livent trials. Besides, Drabinsky is a lawyer, not an accountant, and would not understand Livent’s complex accounting, Roebuck argued. “It’s all very well for the Crown to imply that despite all these functions [Drabinsky] could still monitor the accounting affairs, but that is simply too much for one individual,” Roebuck said. “He didn’t have the training. He didn’t have the time.”

But that is at odds with the portrait of Drabinsky painted by many of the witnesses who testified at the trial, as well as by documents entered as evidence. Both Eckstein and Messina testified that Drabinsky had an intimate knowledge of Livent’s accounting. He even bragged about it: “Mr. Drabinsky was sophisticated in accounting and terminology, and on many occasions he told me he is smarter than any accountant,” Eckstein told the court.

You didn’t need to be a chartered accountant to see that Livent was cooking the books, prosecutors argued. Every quarter Eckstein created an “Executive Summary” of the company’s financials on a simplified one-page sheet that he said was distributed to senior company managers. Each summary contained the line “net income reported” that showed how much profit Livent expected to present to investors and regulators. But there was also another line, “net income actual,” that showed how much money the company actually made — or actually lost — during the same period. The report also highlighted how much money had been “rolled” to future periods, and other accounting manipulations.

Those management summaries are at the heart of the prosecution’s case; Crown lawyers submitted more than a dozen of them as evidence at trial. Many of the documents were discovered in Drabinsky’s office — some with notes and other scribbles in what witnesses testified was Drabinsky’s own handwriting. Those summaries clearly show Drabinsky knew about the manipulations and was actively involved, prosecutors argued. If Eckstein was cooking the books on his own, why in the world would he produce the summaries and present them to senior management?

Defence lawyers disputed whether the documents were actually found in Drabinsky’s office. Livent officials and their lawyers could have easily planted the incriminating documents during a “flawed and biased” investigation following the suspension of the two executives. Many of the documents are anything but clear, suggested the defence. Just because there are discrepancies between the “reported” income numbers and the “actual” numbers does not necessarily connote fraud, argued Roebuck. And the term “actual” net income is ambiguous and may not actually mean actual, Roebuck suggested. Even the judge was a little stunned by that argument. “So, is it your submission that when the report says ‘net reported income’ and ‘net actual income’ those phrases are ambiguous?” Benotto asked during final arguments.

“Yes,” replied Roebuck.

Ekstein is “corrupt” and Messina is “Machiavellian”

The judge should ignore the evidence of Eckstein and Messina, the defence argued. Both pleaded guilty in the U.S. to participating in the Livent fraud, but have yet to be sentenced as part of their plea bargains. Messina was not charged with fraud in Canada, but Eckstein pleaded guilty to a single count of fraud in 2007. He got a conditional sentence with no jail time.

In addition to being an accomplice in the fraud, Eckstein is a corrupt, deeply flawed bully who ruled Livent’s accounting department with fear and intimidation, the defence suggested. Even prosecution witnesses agreed that Eckstein was an odious manager whom they often referred to as “Sybil” — a reference to the 1970s film and book about a woman with multiple personality disorder. “He could be the nicest, gentlest person one minute and just be a vile human being 30 seconds after that,” Messina testified at the trial. “I had terrible run-ins with him. The verbal abuse was just unimaginable.”

Messina is not much better, defence lawyers insisted. The former Livent auditor who left Deloitte & Touche in 1996 to become the company’s CFO, has portrayed herself as the “whistle-blower” but she is little more than an “opportunist” who is a biased and unreliable witness, the defence argued. Defence lawyers suggested that Messina’s hiring actually proves their clients did not know about the fraud and cited the move as “a pillar of reasonable doubt” in final arguments. Nobody engaged in fraud would hire their former auditor as CFO; the risk of exposure would be too great, the defence argued. That argument sounds convincing until you realize that now-infamous Enron Corp. recruited heavily from its accounting firm Arthur Andersen and that new corporate governance rules in Canada and the U.S. now ban the practice. Since the collapse of Livent in 1998, Messina has been paid more than $2.95 million by Livent’s lawyers, Stikeman Elliot LLP, for work in support of the company’s $100-million lawsuit against Drabinsky and Gottlieb as well as its $450-million suit against Deloitte & Touche. “[Messina] has been a paid witness ‘in waiting,'” said Drabinsky’s lawyer, Eddie Greenspan. “Messina has shown no compunction to continuously lie.” The defence spent weeks grilling witnesses about the events that occurred after the April 1998 announcement that Drabinsky and Gottlieb had sold a controlling stake in Livent to Ovitz and would hand day-to-day control of the company to his financial managers. Shortly after the announcement, Eckstein and Livent controller Chris Craib say they attended a meeting with Drabinsky where he openly discussed plans to manipulate the company’s first-quarter financial results. That meeting never took place, the defence contended, and they have a picture that proves it.

That meeting took place on April 24 at around 2 p.m. in Livent’s downtown Toronto offices, Craib first told investigators. But at that time Drabinsky was flying back to Toronto in Livent’s private jet after attending a gala Ragtime-themed Democratic Party lunch in Washington, D.C., with President Bill Clinton. The defence even introduced a photo taken at the lunch — of Drabinsky, Clinton and Drabinsky’s “mistress” — to prove his attendance. Craib insisted that he merely got the time of the meeting wrong — and that Drabinsky returned to Livent’s offices later that afternoon.

After learning about the meeting from Craib, Messina testified she wrote a memo threatening not to support Livent’s financial statements to the company’s auditors or board of directors. Following a meeting with her, Drabinsky and Gottlieb backed down from their plan, Messina told the court. However, defence lawyers pointed out that in Messina’s memo and subsequent meeting, she never used the word “fraud” or anything else that would imply criminal wrongdoing. The memo and meeting were part of a “sinister and malicious” plan by Messina and Craib to put themselves in a positive light with new Ovitz managers. “It is not an overstatement to describe this memorandum as both self-serving and Machiavellian,” said Brian Greenspan.

Motive, motive, who’s got the motive?

Defence lawyers cited the Ovitz deal as well as the firing of COO Topol as further “pillars of reasonable doubt” and evidence their clients knew nothing about the fraud. A due diligence investigation conducted before the deal was finalized, as well as the installation of new managers, would have inevitably led to discovery of the fraud, defence lawyers argued. And firing Topol is just as crazy since he could easily have “squealed” on the alleged fraud, said Eddie Greenspan. “This is an irrational act if Topol is a co-conspirator. …. It’s illogical that two fraudsters would fire a third fraudster for stealing a small amount of money.”

But the judge didn’t seem to be buying it. During final arguments, she asked Eddie Greenspan if the massive writedown taken before the Ovitz deal could have cleared up much of the fraud on Livent’s books and given Drabinsky and Gottlieb enough comfort to both fire Topol and invite Ovitz to examine the books. In a five-part answer, Greenspan suggested the writedown would not have concealed evidence of a fraud from Ovitz, nor would it have insulated Drabinsky and Gottlieb from accusations levelled by an angry Topol.

Drabinsky and Gottlieb had little to fear from Topol since he was “up to the eyeballs in the fraud,” Chief Crown lawyer Robert Hubbard said in his final rebuttal to the defence arguments. Had Topol “squealed” about the fraud, he would have been in as much legal jeopardy as his co-conspirators. “Topol was not likely to confess to anyone,” said Hubbard.

Drabinsky and Gottlieb may not have been nervous about opening their books to Ovitz or even turning over day-to-day management of the company to his managers. After all, Livent’s own auditors, Deloitte & Touche, had conducted far more intrusive and aggressive audits every year and failed to find any hint of an alleged ongoing fraud, let alone a fraud that the executives may well have thought had been wiped clean by the $27.5-million writedown announced prior to the Ovitz deal.

The Livent executives may not have been scared about the new managers brought in to run the company, either. As part of the Ovitz deal, Drabinsky stepped down as chairman and CEO and handed company management to Roy Furman, a New York investment banker. Furman and Drabinsky had a long and collegial relationship. Drabinsky employed Furman’s company and consulted him extensively during his tumultuous time as Cineplex CEO. “Roy’s an effervescent, enthusiastic character, effusive, but also loyal, supportive and always ready with cogent advice,” Drabinsky wrote in his autobiography. If Drabinsky and Gottlieb had been aware of the alleged fraudulent manipulations to their books, could they have been counting on Furman’s “loyal” and “supportive” nature to discretely handle any potentially embarrassing accounting revelations? If so, they would be sorely disappointed. As the heads of Livent, Drabinsky and Gottlieb had the strongest motive to engage in accounting fraud, prosecutors argued. However, the fact neither executive sold a single share of the more than $60 million worth of stock both men held, undercuts that theory, the defence argued. “The prosecution’s position that Mr. Drabinsky and Mr. Gottlieb had the most to gain and the most to lose as a motivation for fraud, ignores the fact that at no time did Mr. Drabinsky or Mr. Gottlieb do as fraudsmen do — cash out,” said Brian Greenspan.

Prosecutors also found evidence of motive in an unusual place: a letter Drabinsky wrote to Karen Poppell — the same woman photographed with him at that Washington lunch. In the undated, emotional and handwritten letter, Drabinsky says he has finally “come clean” with his wife about their passionate affair, but also complains about an “impossible level of personal debt” that he had been struggling for five years to get out from under. The defence dismissed the letter outright and complained that it’s not even clear when it was written or if it was ever sent.

While not cited by prosecutors, a passage from the letter could provide another explanation why Drabinsky may have gone to such lengths to deceive investors — and it has nothing to do with money. In the letter, Drabinsky tells Poppell that he should have told her that he was not going meet a March 31 “deadline” — apparently, for Drabinsky to leave his wife. He did not tell Poppell of his plans because “I never wanted to admit weakness to you or dilute your confidence in me,” Drabinsky writes. Having to admit that Livent was losing money — and lots of it — would certainly have diluted the confidence of investors, creditors, critics and Drabinsky’s legions of fans and supporters. Was it easier for Drabinsky to fiddle with the company’s books than admit that he could not realize his vision of bringing spectacular, crowd-pleasing musical productions to stages in Chicago, New York and Toronto? By pushing expenses further into the future, did he gamble that he could produce another mega-hit like The Phantom of the Opera that would solve Livent’s accounting problems and make that vision a reality?

Judge Benotto has ordered lawyers to return to court on Feb. 2 — Groundhog Day — to set a date when she will deliver her verdict.