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June 29, 2001


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




A. FRAUDULENT "REVENUE-GENERATING" TRANSACTIONS ..................... 336 1. Pace Theatrical Group ......................................... 336 2. American Artists .............................................. 336 3. CIBC Wood Gundy Capital ....................................... 337 4. Dundee Realty Corporation ..................................... 337 5. Pantages Theatre Naming Rights ................................ 339 6. Dewlim Investments Limited .................................... 340 B. FRAUDULENT MANIPULATION OF LIVENT'S BOOKS AND RECORDS ............ 341 C. OTHER FRAUDULENT CONDUCT ......................................... 344 1. The Undisclosed Kickbacks ..................................... 344 2. Materially False and Misleading Statements to Analysts ........ 344 3. Fraudulent Ticket Purchases ................................... 344 D. ALLEGATIONS OF MISCONDUCT SPECIFIC TO D & T ...................... 345 E. ALLEGATIONS OF MISCONDUCT SPECIFIC TO CIBC ....................... 345 F. LIVENT'S BANKRUPTCY .............................................. 346
A. SECTION 10(b) AND SEC RULE 10b-5 ................................. 347 B. SECTION 20(a) .................................................... 351 C. THE 1995 REFORM ACT .............................................. 355 1. Pleading Standards ............................................ 355 2. Policy and Procedural Objectives .............................. 360
A. CIBC's MOTION .................................................... 364 1. Statute of Limitations ........................................ 364 2. Failure to Plead Loss Causation ............................... 365 B. D & T'S MOTION ................................................... 366 1. Scienter ...................................................... 366 2. The Magnitude of the Fraud .................................... 367 3. Livent's Fraudulent Revenue-Generating Transactions ........... 368 a. The Dundee Transaction ..................................... 369 b. CIBC Wood Gundy Transaction ................................ 369 4. Livent's Manipulation of Its Books and Records ................ 370
C. OUTSIDE DIRECTORS' MOTION ........................................ 371 1. Section 10(b) Claims .......................................... 371 2. Section 20(a) Claims .......................................... 372
V. ORDER 373

This case is one of numerous securities class actions that arose out of the events surrounding the collapse of Livent, Inc. ("Livent"). The particular action now before the Court is brought on behalf of Livent stockholders who purchased or otherwise acquired Livent common stock between March 5, 1996 and August 7, 1998 (the "Class Period") and has been the subject of a prior published decision of this Court, In re Livent Sec. Litig., 78 F. Supp.2d 194 (S.D.N.Y. 1999) (Sweet, J.) ("Livent Shareholders I"), familiarity with which is assumed.*fn1


In August 1998, the first of many shareholder actions was brought against Livent and associated individuals and entities. In December 1998, Judge Sweet consolidated the pending actions and approved lead plaintiffs and counsel. In February 1999, plaintiffs herein ("the Shareholders") filed an amended class action complaint against several groups of defendants: Livent's two highest officers, Garth Drabinsky and Myron Gottlieb (the "Inside Directors"); three directors who served on Livent's audit committee, H. Garfield Emerson, A. Alfred Taubman, and Martin Goldfarb (the "Outside Directors" or "Audit Committee"); and Livent's accounting firm, Deloitte & Touche Chartered Accountants ("D & T").

The defendants moved to dismiss on various grounds. In December 1999, Judge Sweet held that: (1) dismissal of the action on forum non conveniens grounds was not warranted; (2) allegations of fraudulent conduct by Drabinsky and Gottlieb were sufficiently particular to state securities fraud claims; (3) the magnitude of alleged accounting fraud was insufficient to infer scienter on the part of D & T; (4) the allegations that the Outside Directors, who as members of the Audit Committee failed to discover various fraudulent schemes by the Inside Directors, were insufficient to plead scienter; and (5) the fact that the Outside Directors were members of the Audit Committee was insufficient to establish that such directors had the control required to satisfy the criteria for "control person" liability under § 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a) (the "Exchange Act" or "1934 Act").

Judge Sweet granted leave to re-plead, and in February 2000, the Shareholders filed the Second Amended Consolidated Class Action Complaint ("SH SAC") now before the Court. Among its changes, the SH SAC for the first time named Canadian Imperial Bank of Commerce ("CIBC"), a major Livent lender and investment banker, as a defendant.

In three separate motions, D & T, CIBC, and the Outside Directors now move to dismiss the SH SAC under Fed. R.Civ.P. 9(b) and the Private Securities Litigation Reform Act of 1995, (the "PSLRA" or the "1995 Reform Act"), Pub.L. No. 104-67, 109 Stat. 737 (1995) (codified at 15 U.S.C. § 77z1-77z2, 78u4-78u5), for failure to plead fraud with particularity and under Rule 12(b)(6) for failure to state a claim for which relief can be granted. For the reasons that follow, the motions are denied in part and granted in part.


The circumstances upon which the Shareholders' claims of fraud are grounded generally fall into two categories; first, certain transactions Livent executed, the accounting for which overstated income; and second, manipulation of Livent's books and records that understated expenses. Some of the claims target the roles of particular defendants in the underlying the events.


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 "Show Boat" and "Ragtime" in various theaters in North America for fees totaling $11.2 million (U.S.). SH SAC ¶ 50. These agreements, contained in contracts or letters, were dated June 15, 1996 and August 8, 1997, with respect to "Show Boat," and December 18, 1996 and August 8, 1997, with respect to "Ragtime." SH SAC ¶ 50. In return for payment of the fees, Pace was to be reimbursed for all theater expenses to present the shows and was entitled to a limited percentage of adjusted gross ticket sales as profit participation. SH SAC ¶ 50. All of these agreements purported to make the fees nonrefundable, even if Livent never made the shows available to Pace.*fn2

The Shareholders allege that pursuant to the terms of the agreements, Livent would not commence staging "Show Boat" until July 1997 and would be responsible for all production costs, running costs and moving costs throughout the tour. SH SAC ¶ 52. Similarly, according to the Shareholders, Livent assumed obligations with respect to the "Ragtime" agreement for substantial performance that would extend beyond 1996 and 1997. SH SAC ¶ 53.

Nevertheless, on the basis of these agreements, and allegedly in violation of Generally Accepted Accounting Principles ("GAAP"), Livent recognized the present value of the fees as revenue in its financial statements in the amounts of $12.2 million for fiscal 1996 and $1.6 million for fiscal 1997. SH SAC ¶ 51. For purposes of Livent's year-end 1996 reconciliation to U.S. GAAP, Livent deferred recognition of $6 million related to the sale of rights to "Ragtime." SH SAC ¶ 51. Livent subsequently improperly recognized that amount in fiscal 1997. SH SAC ¶ 51.

2. American Artists

In 1997, pursuant to an agreement dated September 9, 1997, Livent sold American Artists Limited Inc. ("American Artists"), a Massachusetts-based theater owner and operator, the right to present "Ragtime" in three theaters for a fee of $4.5 million (U.S.). SH SAC ¶ 86. The agreement purported to make the fee nonrefundable, regardless of whether Livent made "Ragtime" available to American Artists. SH SAC ¶ 86.

3. CIBC Wood Gundy Capital

In December 1997, Gottlieb negotiated an agreement purporting to memorialize the sale of an interest in the production rights of "Show Boat" and "Ragtime" in the United Kingdom and other countries to CIBC Wood Gundy, an investment bank and subsidiary of CIBC, Livent's principal banker. SH SAC ¶ 87. In return, CIBC Wood Gundy was entitled to certain royalty payments from the shows. SH SAC ¶ 87. Valued at $4.6 million (Can.) or £ 2 million, the agreement also gave Livent the right, until June 30, 1998, to repurchase the production rights. SH SAC ¶ 87. Based on this agreement, Livent recorded revenue of approximately $4.6 million (Can.) in its financial statements for fiscal 1997. SH ¶ 87.

According to the Shareholders, the CIBC Wood Gundy contract was reviewed by D & T as part of its 1997 audit of Livent. Although fully aware that the contract required Livent to perform over a period of years, D & T allegedly acquiesced to Livent's insistence that all revenue be booked in 1997 — so long as a corresponding amortization liability was also recorded. SH SAC ¶ 87. Thus, the transaction inflated revenue and earnings before interest, taxes, depreciation and amortization (EBITDA), but not earnings, net interest, taxes, depreciation and amortization. SH SAC ¶ 87.

Gottlieb purportedly negotiated a side letter with CIBC Wood Gundy. SH SAC ¶ 90. The side letter provided two mechanisms for CIBC Wood Gundy to recoup its fees and make significant profits. If Livent exercised the repurchase option, Livent would repay all fees, plus £ 112,500, plus any unpaid royalties; if Livent did not exercise the repurchase option, Livent would pay CIBC Wood Gundy an additional royalty equal to 10 percent of the adjusted gross weekly ticket sales of the Broadway production of "Ragtime." SH SAC ¶ 90. Under this arrangement, CIBC Wood Gundy was guaranteed a minimum of an annualized 33 percent return on its original investment, regardless of which option Livent chose. SH SAC ¶ 90.

The transaction was designed to provide Livent with "bridge" financing until it could sell the production rights to a U.K. investor after "Ragtime" opened on Broadway in early 1998. SH SAC ¶ 91. When it became clear in early August 1998 that Livent's new management did not know about the side agreements, Gottlieb asked the managing director of CIBC 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 CIBC Wood Gundy. SH SAC ¶ 91.

4. Dundee Realty Corporation

In May 1997, Livent acquired from the City of Toronto title to lands adjoining the Pantages Theater (the "Pantages Place Lands"). SH SAC ¶ 66. A portion of the Pantages Place Lands were to be used for a new theater, an underground parking garage, and retail space (collectively the "Pantages Place Project"). SH SAC ¶ 66.

Drabinsky and Gottlieb advised the Board that at the end of the second quarter of 1997, Livent had sold the development rights over the land not used by the Pantages Place Project for $7.4 million (Can.) to a third-party, Dundee Realty Corporation ("Dundee"), a Canadian company. SH SAC ¶¶ 67-68. Gottlieb was a director and shareholder of Dundee's parent corporation, Dundee Bancorp Inc. SH SAC ¶ 67. Livent failed, however, to disclose this agreement as a related party transaction in its fiscal 1997 annual report. SH SAC ¶ 67. The purpose of this sale was to enable Dundee to construct a hotel and condominium adjacent to the Pantages Place Project. SH SAC ¶ 67. Livent was also to receive a minority interest in the development company owned by Dundee that was to construct the hotel and condominium. SH SAC ¶ 67.

Under the master agreement for the project, dated June 30, 1997, Livent and Dundee created a joint venture company. SH SAC ¶ 68. However, the parties entered into a related "Put" agreement (the "Put Agreement") that entitled Dundee to withdraw from the project and cause the joint venture, and therefore Livent, to repay Dundee's investment. SH SAC ¶ 68.

In August 1997, the Audit Committee questioned Gottlieb about the timing of the transactions and whether revenue had been properly recognized for the second quarter of FY 1997. SH SAC ¶ 70. According to the Shareholders, under GAAP, the Put Agreement created a material contingency preventing recognition of the $7.4 million as income in 1997. SH SAC ¶ 77. Over Drabinsky's objections, D & T was asked for an opinion with respect to revenue recognition. SH SAC ¶ 70. Peter Chant ("Chant") of D & T reviewed the contract and opined that, because the contract contained a "put" agreement that would require Livent to buy back the same rights at Dundee's request, the sale was not final and revenue should not be recognized. SH SAC ¶ 70.

Gottlieb then represented to the Board and D & T that the Put Agreement had been cancelled. SH SAC ¶¶ 71, 77. On this basis, D & T informed Gottlieb that because the Put Agreement had been removed in August 1997, revenue should be recognized only in the third quarter. Gottlieb ignored this advice, and issued a press release stating revenue for the second quarter which included the development rights revenue. SH SAC ¶ 71.

When Bob Wardell ("Wardell") of D & T learned of the press release, he contacted Gottlieb and demanded a meeting with Livent's Audit Committee. SH SAC ¶ 72. At the meeting, Gottlieb explained that in his opinion the Dundee contract had been finalized in the second quarter, and he would procure confirmation from Dundee and an opinion of counsel supporting his position. SH SAC ¶ 72.

A few days later, at a second special meeting of the Audit Committee with D & T present, Gottlieb presented the legal opinion and purported confirmation from Dundee. SH SAC ¶ 73. Nonetheless, D & T initially refused to accept the accounting treatment and threatened to resign. The D & T representatives then stepped out of the room. SH SAC ¶ 73.

Gottlieb then told the Audit Committee that D & T should resign. Goldfarb said that would be unacceptable and that D & T's resignation would cause too much damage to Livent's reputation. SH SAC ¶ 74. After further discussion, the Board members agreed that they would be willing to reverse the revenue recognition, provided some of the revenue could be made up for in the second quarter, and that a corrective press release could be issued in a manner that saved face. SH SAC ¶ 74.

Chant and Wardell then came back in the room and the parties agreed that Livent would reverse the $6 million revenue line, but would also increase other revenue by $1.2 million, by reversing an assortment of accrued liabilities. SH SAC ¶ 75. Livent then issued a press release, which, according to the Shareholders, D & T "accepted," and which stated in part that "Livent, Inc. . . . has adjusted its accounting treatment for non-theatre real estate transactions to be consistent with U.S. GAAP." SH SAC ¶ 75.

The Put Agreement issue rose again in discussion with the Audit Committee during the year-end audit in April 1998. SH SAC ¶ 77. On April 9, 1998, Gottlieb expressly stated to the Audit Committee that no such agreement or arrangement existed and provided a letter from the Chairman of Dundee as confirmation. SH SAC ¶ 78-79. 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. SH SAC ¶ 79. The letter read in pertinent part as follows: "[W]e wish to confirm that notwithstanding [Dundee's Chairman's] 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." SH SAC ¶ 79.

The Shareholders allege that revenue recognition from this transaction violated GAAP. First, according to the Shareholders, 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. SH SAC ¶ 80. Thus, even if the Put Agreement was cancelled, recognition of revenue was improper because the contract was not a final, consummated sale. Second, On May 27, 1998, Gottlieb and Dundee executed a new Put agreement. SH SAC ¶ 80. Gottlieb and Drabinsky's April 6, 1998 letter "reinstating" the Put Agreement, and the new May 27, 1998 Put agreement confirm that Gottlieb and Drabinsky considered it to be binding on Livent. SH SAC ¶ 80. Accordingly, the existence of the Put Agreement made the transaction an investment that did not qualify for revenue recognition under GAAP. SH SAC ¶ 80.

5. Pantages Theatre Naming Rights

Livent sought to recognize as revenue $12.5 million for a purported sale of naming rights to the Pantages Theatre to AT & T for the third quarter of fiscal 1997. SH SAC ¶ 81. Livent purportedly sold AT & T the right to add its name on two theaters, one of which had not yet been built. SH SAC ¶ 81. Although there had not been any firm contract by the end of the third quarter, Livent wanted to record the revenue immediately based on its plans to allow the name change to the Pantages. SH SAC ¶ 81.

In October 1997, Livent vice-president Maria Messina ("Messina") discussed the transaction with D & T's Wardell and Chant, and all three agreed that the revenue could not be recognized in the third quarter of 1997. Gottlieb, an accountant by profession, retained Ernst & Young ("E & Y") for the purpose of receiving an independent opinion on the naming revenue. SH SAC ¶ 82. While E & Y would not opine that the revenue could be recognized in the third quarter of 1997, it did state that the transaction could be considered within the third quarter. SH SAC ¶ 83. Gottlieb provided D & T with E & Y's opinion regarding the transaction and asked that it be included in the accounting for the third quarter. SH SAC ¶ 83.

D & T retained another accounting firm, Price Waterhouse, for another professional opinion. Price Waterhouse met with Gottlieb and AT & T and concluded that an oral contract could be considered to have occurred in the third quarter of 1997. SH SAC ¶ 84. Price Waterhouse did not opine on the specific issue of revenue recognition with respect to the oral contract. SH SAC ¶ 84.

After receiving this information, D & T acquiesced to recording the naming revenue in the third quarter. SH SAC ¶ 85. The written contract for the name change was thereafter signed in November 1997. SH SAC ¶ 85.

6. Dewlim Investments Limited

In 1996, Gottlieb negotiated the sale of an interest in the production rights to "Show Boat" in Australia and New Zealand to Dewlim Investments Limited ("Dewlim"), a British Virgin Islands company, for $4.5 million. SH SAC ¶ 54. The original agreement was dated October 21, 1996, and revised by agreement dated November 3, 1997. SH SAC ¶ 54.

In October 1996, Gottlieb and Drabinsky orally promised Dewlim's then owner, Andrew Sarlos, that Livent would repay the fee Dewlim advanced for the production rights, plus 10 percent interest. SH SAC ¶ 55. This arrangement is memorialized in a June 9, 1998 memo from Gottlieb to Drabinsky. SH SAC ¶ 55. It states that as "an inducement" for the "Show Boat" transaction, "we committed to Dewlim on behalf of Livent that Dewlim would recoup by December 31, 2000 all capital together with interest accrued monthly at the rate of 10% per annum." SH SAC ¶ 55. As a result of this concealed arrangement, Livent improperly recorded as revenue the present value of the fee, $4.2 million, in fiscal 1996; no revenue was recorded under U.S. GAAP in fiscal 1996 or 1997. SH SAC ¶ 55.

This was a related party transaction in two respects. First, at the time of the transaction, Sarlos was a director of Livent and chairman of Livent's Audit Committee. SH SAC ¶ 56. Additionally, in October 1996, Gottlieb had pledged his personal Livent stock to Dewlim as security for the $4.5 million loan. SH SAC ¶ 56. Neither of these related party transactions was disclosed in Livent's annual report for fiscal 1996 or 1997. SH SAC ¶ 56.

According to the Shareholders, even a cursory examination of the Dewlim agreement — even without the side agreement — raised red flags that Livent could not complete its terms of the agreement to justify the recognition of $4.2 million in 1996.

The Audit Committee reviewed the contents of the Dewlim and Pace agreements. SH SAC ¶ 59. During one Audit Committee meeting Goldfarb and Emerson stated that the revenue recognition in the agreements was improper, and some revenues should be amortized over several years. SH SAC ¶ 59. However, based on a report by D & T and representations of management, they agreed that the revenue could be recognized in 1996. SH SAC ¶ 59.

D & T also reviewed the terms of the Dewlim and Pace agreements, and knew that Messina opposed recognizing all the revenue on the agreements. SH SAC ¶ 60.

D & T's United States affiliate initially refused to permit D & T to file its Audit Opinion on Livent's 1996 U.S. GAAP financial statement with the SEC, because it agreed with Messina that revenue recognition had been improper with respect to those transactions. SH SAC ¶ 60. A meeting was held in New York in early 1998 to consider the proper accounting. Livent was represented by Drabinsky, Gottlieb, and Livent vice-presidents Robert Topol ("Topol"), Gordon Eckstein ("Eckstein"), and Messina and D & T Canada was represented by Wardell and Chant. SH SAC ¶ 61. D & T New York was represented by four partners. SH SAC ¶ 61.


The Shareholders allege that beginning in 1994 and continuing through the first quarter of 1998, Drabinsky and Gottlieb and several of the other Livent officials engaged in a deliberate manipulation of Livent's books and records, thereby understating expenses in each fiscal quarter in order to inflate earnings, and violating GAAP. By redacting expenses on losing shows, Drabinsky and Gottlieb were able to portray the productions and Livent as financially successful. SH SAC ¶ 105. In quarterly periods, this enabled Drabinsky, Gottlieb and Topol to meet the earnings and operating projections provided to Wall Street analysts. SH SAC ¶ 105.

Specifically, the Shareholders claim that Livent's managers engaged in three manipulative devices to falsify Livent's books: (a) transferring preproduction costs for shows to fixed asset accounts, which materially understated expenses; (b) physically erasing expense and liability entries from the Company's general ledger; and (c) transferring costs from a currently running show to another show with a longer amortization period, which again materially understated expenses. SH SAC ¶¶ 96-114.

Livent transferred preproduction costs for shows to fixed asset accounts. SH SAC ¶ 96. Preproduction costs, such as costs for advertising, sets and costumes, were incurred prior to the opening of a production. SH SAC ¶ 96. According to Livent's accounting policies, preproduction costs were amortized, and thus expensed, once a production begins and only for a period not to exceed five years. SH SAC ¶ 96. Fixed assets, in contrast, were depreciated over their useful life, not to exceed forty years. SH SAC ¶ 96. As a result, Livent significantly decreased expenses, and thus inflated its reported income, by improperly depreciating preproduction costs over a much longer period of time. SH SAC ¶ 96. For example, in 1997 Livent transferred preproduction costs and certain show operating expenses totaling $15 million, representing six different shows in 30 different locations, to three different fixed asset accounts. SH SAC ¶ 96. By this manipulation, Livent violated GAAP and its own accounting policy. SH SAC ¶ 96.

Livent also physically erased expense and liability entries from its general ledger, moving these entries from the current quarter to future periods. SH SAC ¶ 97. Livent maintained a separate set of books, called the "Expense Roll," that internally tracked the amount of these eliminated entries. SH SAC ¶ 98. This manipulation allowed Livent to falsely report significant reductions in show expenses, with attendant increases in profits. SH SAC ¶ 98. For example, expenses rolled from the first to the second quarter of fiscal 1997 totaled $6.5 million. SH SAC ¶ 98.

According to the Shareholders' theory, any auditor or Audit Committee member who reviewed Livent's production schedule, or even read the trade publications or Variety magazine, would have noticed clear red flags of this accounting manipulation. The Shareholders maintain that: D & T and the Audit Committee surely were aware of Livent's announced policy that costs of cancelled shows would be expended at the time of cancellation; the fact that particular shows had ended their runs was well known; and absence of any writedown at the time of the show's end necessarily meant that Livent was not following its own stated accounting policy, let alone complying with GAAP. SH SAC ¶ 100.

As had been done with the "Expense Rolls," Livent maintained a separate sets of books called the "Amortization Roll," to internally track the amount of amortization moved from current to future periods. SH SAC ¶ 101.

The cumulative impact of these accounting irregularities caused Livent to understate expenses by $3.5 million in fiscal year 1995, $18 million in fiscal year 1996, and $8.5 million in fiscal year 1997, and to overstate expenses by $2.7 million in the first quarter of fiscal year 1998. SH SAC ¶ 102.

The Shareholders assert that each of the manipulations described above was carried out by Livent's senior management and accounting department personnel. SH SAC ¶ 104. On a quarterly basis, Diane Winkfein ("Winkfein") and D. Grant Malcolm ("Malcolm") — Livent senior controllers — produced a general ledger showing quarterly financial results to Eckstein and Christopher Craib ("Craib"), another senior controller who had joined Livent from D & T in June 1997. Craib then placed this information into summary format for Drabinsky, Gottlieb, Eckstein, and Topol. SH SAC ¶ 105. This group, along with Messina, then met to review the results. SH SAC ¶ 105.

During these meetings, Drabinsky, Gottlieb, Eckstein, Topol, and Messina agreed on the quantity of top-line adjustments to be made to Livent's books to achieve the results they desired. SH SAC ¶ 102. Generally, Drabinsky directed that certain adjustments be made. SH SAC ¶ 106. Eckstein noted the desired adjustments, and communicated the adjustments to Winkfein and Malcolm, instructing them to make the adjustments in such a way as to give the appearance that they were original entries. SH SAC ¶ 106. Beginning in 1996, Malcolm communicated the transfers to fixed asset accounts to Tony Fiorino ("Fiorino"), Livent's theater controller, who recorded the adjustments in dummy theater cost accounts. SH SAC ¶ 106.

Once the top-line adjustments were made, Winkfein or Malcolm provided Eckstein with an adjusted general ledger containing the accounting manipulations. SH SAC ¶ 107. Drabinsky, Gottlieb, Topol, and Eckstein then met to review the manipulated results. SH SAC ¶ 107. Drabinsky directed that further adjustments be made, which Winkfein or Malcolm processed in Livent's accounting system, under Eckstein's direction. SH SAC ¶ 107. After a final review by senior management, the manipulated numbers were presented to Livent's Audit Committee, D & T and investors, and were eventually incorporated into Livent's public filings with the SEC. SH SAC ¶ 107.

Due to the sheer magnitude of the manipulations, it was necessary to track results both before and after the top-line adjustments were made. SH SAC ¶ 108. At Eckstein's direction, Malcolm maintained computer files of the adjustments that tracked details of expense capitalization, expense rolls, and show-to-show cost transfers from 1995 to the first quarter of 1998. SH SAC ¶ 108. Fiorino also separately tracked the expenses that had been improperly transferred to theater construction accounts by creating a range of accounts in the general ledger and thereby measuring the true costs of Livent's theater construction program. SH SAC ¶ 108.

To make the adjustments, Malcolm identified individual invoices to alter. SH SAC ¶ 111. Then, on an invoice-by-invoice basis, he and Winkfein changed the distribution dates or account codes of these invoices, deleting the original entries from Livent's general ledgers and reposting fraudulent information. SH SAC ¶ 111. This process had the effect of making the adjusted entries appear as original transaction figures. SH SAC ¶ 111.

Beginning in mid-1997, Eckstein directed Craib to prepare quarterly schedules containing a comparison of actual and budgeted results. SH SAC ¶ 109. These schedules, which contained the "Expense Roll" and the "Amortization Roll," quantified certain of the accounting manipulations. SH SAC ¶ 109. Drabinsky, Gottlieb, Topol, Eckstein, and Messina met to review these schedules. SH SAC ¶ 109. Beginning by at least October 1997, Messina prepared pre- and post-adjustment charts reflecting transferred amounts in detail, which she distributed to Drabinsky, Gottlieb, Topol, and Eckstein. SH SAC ¶ 109. After these meetings, Winkfein, Malcolm and Fiorino made adjustments to various accounts in the balance sheet and income statement, including expense categories, specific shows and fixed asset accounts. SH SAC ¶ 110.

The amount and magnitude of the adjustments eventually grew so great that it was not possible to make individual changes to Livent's general ledger. SH SAC ¶ 112. Eckstein directed Malcolm to instruct Livent's information services department to write a computer program that would allow the accounting staff to override Livent's accounting system. SH SAC ¶ 112. Livent's information services manager wrote computer programs to enable the accounting staff to execute adjustments on a batch basis. SH SAC ¶ 112.

With respect to the transferral of expenses from one show to another, Livent's policy was to expense costs of canceled shows at the time of cancellation, and it was well known when a particular show had ended its run. SH SAC ¶ 100. That no writedown was taken at the end of a show's run meant, the Shareholders contend, that Livent was not following its own accounting policy, and that D & T either knew it or was reckless in failing to recognize it. SH SAC ¶ 100. With respect to all of the accounting manipulations, the magnitude of the top-end adjustments was so great, and the existence of red flags so clear, that the misconduct should have been detected through independent confirmation procedures carried out in an audit conducted in accordance with Generally Accepted ...

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