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IN RE LIVENT

December 10, 1999

IN RE LIVENT, INC. SECURITIES LITIGATION. THIS DOCUMENT RELATES TO ALL ACTIONS.


The opinion of the court was delivered by: Sweet, District Judge.

      OPINION

Defendants Garth A. Drabinsky ("Drabinsky"), Myron Gottlieb ("Gottlieb"), Robert Topol ("Topol"), Maria M. Messina ("Messina"), H. Garfield Emerson ("Emerson"), Martin Goldfarb ("Goldfarb"), A. Alfred Taubman ("Taubman"),*fn1 and Deloitte & Touche Canada ("D & T"), have moved to dismiss this action, pursuant to Rule 9(b) of the Federal Rules of Civil Procedure, for failure to plead scienter and fraud with sufficient particularity. Additionally, Drabinsky, Gottlieb, Topol, Messina, and D & T move to dismiss on the grounds of forum non conveniens. Drabinsky and Gottlieb further move, pursuant to Rule 12(f), to strike certain allegations in Plaintiffs' complaint. For the reasons set forth below, the motions are granted in part and denied in part.

The Parties

Plaintiffs are members of a class of persons (the "Class") who purchased or acquired the common stock of Livent, Inc. ("Livent" or the "Company") between March 5, 1996 and August 7, 1998 (the "Class Period"). The Class representatives include both U.S. and Canadian citizens.

Livent is a Canadian-based producer of live theatrical entertainment, including "Ragtime," "The Phantom of the Opera," "Showboat," "Sunset Boulevard," and "Fosse." The Company owns and/or operates theatres in Toronto, Vancouver, Chicago, and New York. Livent became a public company in Canada in May 1993 and registered its common stock in the United States in May 1995. The Company is named as a nominal defendant. It filed for bankruptcy protection in the United States on November 19, 1998, and all proceedings against it are stayed.

Drabinsky was a co-founder of Livent, and Chairman of its Board of Directors (the "Board") and Chief Executive Officer from December 1989 until June 15, 1998. From June 15 until August 10, 1998, he held the position of Vice Chairman and Chief Creative Director of the Company. He was suspended on August 10 and fired on November 18, 1998. Drabinsky is a Canadian citizen and resident. He owns an apartment in Manhattan.

Gottlieb was a co-founder of Livent, President and Chief Operating Officer from December 1989 until June 15, 1998, a member of the Board from 1993 to 1998, and Executive Vice-President of Canadian Administration from June 15, 1998 until August 10, 1998, at which point he was suspended. He was fired on November 18, 1998. Gottlieb is a Canadian citizen and resident.

Topol was Livent's Executive Vice President from 1989 until 1994, when he became Senior Executive Vice President. He was Chief Operating Officer from 1997 until his resignation on February 25, 1998. Topol is a Canadian citizen and resident.

Messina joined Livent in May 1996 as Vice President of Finance. Previously, she had been D & T's engagement partner for Livent's 1995 audit, and had worked on Livent's audits since 1993. In November 1996, she became the Company's Chief Financial Officer, and subsequently its Senior Vice President of Finance and Administration. Messina is a Canadian citizen and resident.

Emerson was a member of Livent's Board of Directors and served as Chairman of the Audit Committee during the Class Period. Defendants Goldfarb and Taubman were members of the Board and of the Audit Committee. Emerson and Goldfarb are Canadian residents. Taubman is a U.S. citizen and resident.

D & T is a Canadian entity affiliated with Deloitte & Touche, L.L.P., a United States limited liability partnership. D & T served as Livent's auditor and principal accounting firm prior to and continuing through the Class Period.

Prior Proceedings

The first of the numerous actions arising from the events described below was filed with this Court on August 11, 1998. A December 3, 1998 order of this Court consolidated the pending actions and approved of the selection of lead plaintiffs and counsel.

On January 13, 1999, the Securities and Exchange Commission (the "SEC") filed a separate suit against Drabinsky, Gottlieb, Topol, Messina, and other former officers and employees of the Company, for alleged violations of the securities laws arising out of the same events as those giving rise to the instant action. See SEC v. Drabinsky et al., No. 99 Civ. 0239 (S.D.N.Y.).

On February 1, 1999, Plaintiffs in this action filed an amended class action complaint.

Defendants filed the instant motions on May 14, 1999. Memoranda of law in support and opposition, and declarations and affidavits, were received through September 8, 1999, at which point oral argument was heard and the motions were deemed fully submitted.

Background

On a motion to dismiss under Rule 9(b) or Rule 12(b)(6), the facts alleged in the complaint are presumed to be true, and all factual inferences are drawn in the plaintiff's favor. See Mills v. Polar Molecular Corp., 12 F.3d 1170, 1174 (2d Cir. 1993). Accordingly, the facts presented here are drawn from the allegations of Plaintiffs' amended class action complaint (the "Complaint") and do not constitute findings of fact by the Court.

The presumption on factual inferences does not apply to a forum non conveniens motion. A forum non conveniens inquiry goes to the court's subject matter jurisdiction over the action, and "[i]n resolving the jurisdictional dispute, the district court must review the pleadings and any evidence before it, such as affidavits." Cargill Intern. S.A. v. M/T PAVEL DYBENKO, 991 F.2d 1012, 1019 (2d Cir. 1993).

Livent, formed in 1989, was a seemingly successful producer of live theatre. It became a publicly traded company on the Toronto Stock Exchange in May 1993, and subsequently registered its common stock in the United States in May 1995. Throughout the Class Period, Livent's common shares were actively traded in the United States on NASDAQ. Trading in the stock on NASDAQ exceeded trading on the Toronto Exchange by a ratio of 3 to 1. During this time, Livent filed with the SEC quarterly and annual reports for the fiscal years 1995, 1996, and 1997.

Throughout the Class Period, Livent obtained sizeable amounts of American capital to finance its business activities, in each instance filing a Registration Statement and Prospectus with the SEC. For example, on or about April 2, 1996, the Company completed a U.S. equity offering raising $29.5 million through the issuance of 3.75 million shares of common stock. In October 1997, Livent raised $120 million by issuing 9 3/8% unsecured notes offered to American and Canadian investors.

In 1998, Drabinsky approached Lynx Ventures, L.P. ("Lynx"), a company headed by Michael Ovitz ("Ovitz"), a prominent Hollywood entertainment executive. Lynx invested $20 million in Livent in return for 2.5 million shares, or 12% of the Company. As part of the deal, Drabinsky and Gottlieb relinquished voting control of their shares and stepped down from their management positions, assuming purely creative roles. Roy Furman ("Furman"), a Wall Street financier, was installed as Chief Executive Officer, David Maisel ("Maisel") became President, and Robert Webster ("Webster") became Executive Vice President.

A few months later, Webster discovered that the Company had entered into certain agreements, described in more detail below, that, while appearing to be revenue generating deals, were potentially worthless. Webster asked the staff whether there were any other unusual financial situations that had not been disclosed. On August 6, 1998, a handful of Livent personnel, led by Messina, admitted that they had information that would cast doubt on the veracity and accuracy of Livent's financial reports. Over the next two days, Webster and attorneys from the law firm of Stikeman Elliot began interviewing employees.

On the evening of Sunday, August 9, the company's directors gathered by conference call in Toronto. Ovitz, Furman, and Maisel were joined by several other directors; Gottlieb and Drabinsky were not invited. The directors concluded that Livent's financial statements for 1996 and 1997 and the first quarter of 1998 would need to be restated as soon as possible after KPMG Investigation and Security Inc. could review the Company's books for any more accounting irregularities. In the meantime, Gottlieb and Drabinsky would be suspended from their management positions.

The next day, the Company issued a press release announcing that it would restate its previously reported financial results for the fiscal years 1996 and 1997 and the first quarter 1998, because it had uncovered serious irregularities in the Company's financial records. NASDAQ and the Toronto Stock Exchange immediately halted trading of the Company's stock. Drabinsky and Gottlieb were formally suspended by the Board.

On November 19, 1998, the Company also (a) filed for bankruptcy in the United States, (b) sued Drabinsky and Gottlieb, and (c) fired the two men. The Company's lawsuit seeks $225 million in damages; Drabinsky and Gottlieb countered with their own suit, claiming a conspiracy by the Company.

On December 14, 1998, defendant Messina and four of her assistants were fired by the Company. On December 16, the Royal Canadian Mounted Police raided Livent's offices as part of the investigation being conducted by its Commercial Crime Unit, which looks into fraud and stock market manipulation cases.

The SEC suit filed on January 13, 1999 against Drabinsky, Gottlieb, Topol, Messina, and other former officers and employees of the Company, alleges "a multifaceted and pervasive accounting fraud spanning eight years from 1990 throughout the first quarter of 1998." The SEC is seeking to bar permanently Drabinsky, Gottlieb, Topol, and Gordon Eckstein ("Eckstein," who is not a moving party here but is a defendant in the instant action) from serving as officers or directors of public companies. See SEC v. Drabinsky et al., No. 99 Civ. 0239 (S.D.N.Y.). The SEC simultaneously announced that it had already settled related civil and administrative actions against, among others, Eckstein.

The gravamen of the Complaint in this action is that the Individual Defendants fraudulently portrayed the financial condition of Livent to the public, and that D & T knew, or was reckless in not knowing, of the fraud. The Individual Defendants are alleged to have understated expenses in order to inflate earnings; recognized as revenue what in reality were loans; portrayed unsuccessful theatrical productions as profitable; and fabricated earnings results to meet quarterly and annual projections the Company provided to Wall Street analysts. The cumulative pre-tax effect of the alleged accounting irregularities totaled more than Canadian $98 million.*fn2 Defendants allegedly achieved this manipulation in at least four ways:

(a) various sales agreements between Livent and third parties contained side agreements that required Livent to pay back amounts advanced by the other parties to the agreements; thus, transactions that were booked as revenue should have been booked as loans;

(b) costs associated with particular shows (that would otherwise be expensed in a particular time period) were transferred to fixed asset accounts and capitalized;

(c) costs from a currently running show were transferred to another show that had not yet opened or that had a longer amortization period; and

(d) expense and accounts payable entries were removed from the books and records of Livent.

Drabinsky, Gottlieb, Eckstein, Topol, and Messina are alleged to have actively participated in the fraud. Two senior level controllers, Diane Winkfein ("Winkfein") and Grant Malcolm ("Malcolm"), effected the accounting adjustments directed by Eckstein; Malcolm also maintained separate records showing the adjustments so that Drabinsky, Gottlieb, and others could track the manipulations and know Livent's true financial condition. Livent's theatre controller, Tony Fiorino ("Fiorino"), knew about the accounting manipulations and participated in the fraudulent transfers to fixed asset accounts.

As a further result of the scheme, Livent reported preproduction costs or fixed assets that were fraudulently overstated for fiscal years 1994 through 1997. For fiscal 1994, 1995 and 1996, respectively, Livent reported preproduction costs of $28 million, $55.4 million and $75.6 million. Each of these amounts was materially overstated. In addition, for fiscal 1996, Livent reported fixed assets of $133.2 million, which was materially overstated by at least $6 million. For fiscal 1997, Livent reported fixed assets of $200.8 million, which was materially overstated by approximately $23.9 million.

In November 1998, following the discovery of the fraud and a subsequent independent investigation, Livent restated the Company's financial statements for the years 1996 through the first quarter of 1998. D & T then withdrew its original audit opinion on the Company's financial statements for the years 1995 through 1997. The restatement resulted in a cumulative adverse effect on net income in excess of $98.2 million.

When trading briefly resumed following release of the restatement, Livent stock plummeted over ninety-five percent, from U.S. $6.75 per share to approximately U.S. $.28 per share, and lost over $100 million in market capitalization. On January 6, 1999, NASDAQ delisted the Company.

As indicated in Livent's proxy statement dated April 16, 1997, during the Class Period the mandate of Livent's Board was to supervise the management of the business and affairs of the Company and to act with a view to the best interests of the Company. In fulfilling its mandate, the Board, among other matters, was to discuss the strategic planning process of the Company with senior executives, review the annual budget of the Company, consider the interim unaudited financial statements for the first three quarters of the fiscal year of the Company, approve the annual audited financial statements of the Company, and, in conjunction with the quarterly reviews, analyze any major variances between the actual performance of the Company to that contained in the current budget and to that of the performance for the comparable period in the preceding fiscal year.

The Audit Committee of the Livent Board was responsible for reviewing the Company's financial reporting procedures, internal controls and management information systems, and the performance of the Company's external auditors. The Audit Committee, prior to a general review by the Board, was also responsible for reviewing the quarterly unaudited financial statements and the annual audited financial statements. Such quarterly reviews were to extend to a review of management's estimates of the unamortized preproduction costs of the various productions undertaken by the Company in order to determine whether any adjustment thereto was required pursuant to the forecasting methodology adopted by the Company.

The Specifics of the Fraud

A. Fraudulent "Revenue-Generating" Transactions

The Individual Defendants are alleged to have caused Livent to enter into agreements with third parties that included undisclosed side agreements, obligating Livent to repay, in part or in whole, sums earned under the agreements. (Compl. ¶ 30.) Under U.S. and Canadian Generally Accepted Accounting Principles ("GAAP"), funds received on an understanding that they are to be repaid are not revenue. (Id. ¶ 31.) Nevertheless, Livent's audited financial statements for fiscal years 1995, 1996 and 1997 improperly recorded at least $34 million in revenue through the following transactions orchestrated by "Drabinsky, Gottlieb and the others"

1. Pace Theatrical Group

In 1996 and 1997, Livent purported to sell Pace Theatrical Group, Inc. ("Pace"), a Texas-based theatrical company, the exclusive rights to present "Showboat" and "Ragtime" in various theatres in North America for fees totaling U.S. $11.2 million. These purported agreements were contained in contracts or letters dated June 15, 1996 and August 8, 1997, with respect to "Showboat," and December 18, 1996 and August 8, 1997, with respect to "Ragtime." Each of these agreements was signed, and in part negotiated, at Pace's office in New York City. In return for payment of the fees, Pace was to be reimbursed for all theatre expenses to present the shows and was entitled to a limited percentage of adjusted gross ticket sales as profit participation. All of these agreements purported to make the fees nonrefundable, even if Livent never made the shows available to Pace. (Id. ¶ 35.)

On the basis of these agreements, Livent recognized as revenue in its financial statements the present value of the fees in the amounts of $12.2 million for fiscal 1996 and $1.6 million for fiscal 1997. For purposes of the Company's year-end 1996 reconciliation to U.S. GAAP, Livent deferred recognition of $6 million related to the sale of rights to "Ragtime". Livent subsequently improperly recognized that amount in fiscal 1997. (Id. ¶ 36.)

However, the agreements did not actually require any irrevocable payments by Pace. Pace required side letters to these agreements that granted Pace the right to recoup its fees, plus earn additional profit, as the shows were performed. These side letters were dated the same date, or days or weeks after the underlying sales agreements: the side letters for "Showboat" were dated June 17, 1996 and August 20, 1997; and the side letters for "Ragtime" were dated December 18, 1996 and August 20, 1997. Each of these side letters was signed, and in part negotiated, at Pace's office in New York City. (Id. ¶ 37.)

2. American Artists

In 1997, pursuant to an agreement dated September 9, 1997, Livent sold American Artists Limited Inc. ("American Artists"), a Massachusetts-based theatre owner and operator, the right to present "Ragtime" in three theatres for a fee of U.S. $4.5 million. The agreement purported to make the fee nonrefundable, regardless of whether Livent made "Ragtime" available to American Artists. However, two side letters, dated September 29 and November 15, 1997, signed by Topol and by American Artists, permitted American Artists to recoup its fees in two ways: through fixed weekly amounts when the shows were performed, and through "consulting fees" for the services of American Artists' president, Jon Platt. These side letters, as well as the September 9, 1997 rights agreement, were signed, and negotiated in part, in November 1997 in New York City. As a result, Livent fraudulently recorded approximately $5.8 million, the present value of the fee, in its financial statements for the third quarter of 1997 and fiscal 1997. (Id. ¶ 39.)

3. CIBC Wood Gundy Capital

In December 1997, Gottlieb negotiated a contract purporting to memorialize the sale of an interest in the production rights of "Showboat" and "Ragtime" in the United Kingdom and other countries to CIBC Wood Gundy Capital ("Wood Gundy"), an investment bank and subsidiary of the Canadian Imperial Bank of Commerce, Livent's principal banker. In return, Wood Gundy was entitled to certain royalty payments from the shows. The agreement, valued at $4.6 million, also gave Livent the right, until June 30, 1998, to repurchase the production rights. Under the agreement, the fee from Wood Gundy was nonrefundable, and Livent had no obligation to stage the plays or to exercise its repurchase option. Thus, Wood Gundy purportedly assumed all risks that it would never recoup any fees or make any profit from the transaction. These terms were set out in an agreement dated December 23, 1997. Based on this agreement, Livent recorded revenue of approximately $4.6 million in its financial statements for fiscal 1997. (Id. ¶ 41.)

In fact, Gottlieb had negotiated two side letters with Wood Gundy, both of which were also dated December 23, 1997. The side letters provided two mechanisms for Wood Gundy to recoup its fees and make significant profits. If Livent exercised the repurchase option, Livent would repay all fees, plus 112,500 British pounds, plus any unpaid royalties; if Livent did not exercise the repurchase option, Livent would pay Wood Gundy an additional royalty equal to 10% of the adjusted gross weekly ticket sales of the Broadway production of "Ragtime," which was expected to run for years and generate a weekly royalty of approximately U.S. $90,000. Based on this arrangement, Wood Gundy would earn at least a 40% return if Livent repurchased the rights, and well over 100% if Livent did not. (Id. ¶ 43.)

The transaction provided Livent with "bridge" financing until it could sell the production rights to a U.K. investor after "Ragtime" opened on Broadway in early 1998. When it became clear in early August of 1998 that Livent's new management did not know about the side agreements, Gottlieb asked the managing director of Wood Gundy who negotiated the transaction not to disclose the side agreements to new management so that Gottlieb could cause Livent to repurchase the rights from Wood Gundy. (Id. ¶ 44.)

4. Dundee Realty Corporation

In May 1997, Livent acquired from the City of Toronto title to lands adjoining the Pantages Theatre (the "Pantages Place Lands"). A portion of the Pantages Place Lands were to be used to extend the backstage of the existing Pantages Theatre, to commence construction in 1999 of a new theatre of approximately 1,400 seats, and to construct an underground parking facility and approximately 3,300 square feet of retail space (collectively the "Pantages Place Project"). (Id. ¶ 45.)

Drabinsky and Gottlieb advised the Livent Board that at the end of the second quarter of 1997, Livent had sold the excess density rights over its existing theatre and its theatre expansion and the density rights over the land not used by the Pantages Place Project for $7.4 million to a third-party corporation, Dundee Realty Corporation ("Dundee"), a Canadian company. Gottlieb was a director and shareholder of Dundee's parent corporation, Dundee Bancorp Inc. However, Livent failed to disclose this as a related party transaction in its fiscal 1997 annual report. The purpose of this sale was to enable Dundee to construct a hotel/condominium on a portion of the Pantages Place Lands not to be used in the Pantages Place Project. Livent was also to receive a minority interest in the development company owned by Dundee that was to construct the hotel/condominium. (Id. ¶ 46.)

Under the master agreement for the project, dated June 30, 1997, Livent and Dundee created a joint venture company and Livent sold Dundee the excess density rights over the land for $7.4 million. However, the parties entered into a separate "Put" agreement (the "Put Agreement"), dated August 15, 1997, enabling Dundee to withdraw from the project and cause the joint venture, and therefore Livent, to repay Dundee's investment. (Id. ¶ 47.)

The issue rose again in discussion with the Audit Committee during the year-end audit in April 1998. On or about April 9, 1998, Gottlieb expressly stated to the Audit Committee that no such put agreement or arrangement existed and provided a letter from the Chairman of Dundee as confirmation. However, in a letter dated April 6, 1998 to Dundee's President, Drabinsky and Gottlieb confirmed to Dundee that the Put Agreement was in place and effective as between Livent and Dundee. The letter read in pertinent part as follows: "accordingly, we wish to confirm that notwithstanding [Dundee's Chairman] letter to me of April 4, 1998, a copy of which is attached hereto, the "PUT" agreement referred to in [Dundee's Chairman] letter is binding and effective and remains so in favor of Dundee . . . as if it had never been cancelled." (Id. ¶ 50.)

Revenue recognition from this transaction violated GAAP in two ways. First, any oral agreement to cancel the Put Agreement was contingent upon Gottlieb renegotiating the joint venture agreement to ensure to Dundee's satisfaction that Dundee's rights remained secure. Thus, even if the Put Agreement was canceled, recognition of revenue was improper because the contract was not a final, consummated sale. Second, Gottlieb and Drabinsky's April 6, 1998 letter "reinstating" the Put Agreement, and the new May 27, 1998 Put agreement, which Gottlieb entered into with Dundee, confirm that Gottlieb and Drabinsky considered it to be binding on Livent ...


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