Welcome back. And in this last lesson, we're going to cover off another case study. And this time we're going to look at one of Canada's most notorious frauds. This one happened about two decades ago, yet is still unresolved to this day. Live. It was founded in 1989 by Garth Dubinsky, and Myron Gottlieb, and these two characters acquired the theatrical divisions from Cineplex Odeon.

The primary assets at the time of acquisition were the penthouse Theatre in Toronto, and the rights to Andrew Lloyd Webber's most popular musical The Phantom of the Opera live event went on to stage a number of award winning theatrical productions such as Showboat and Ragtime and Sunset Boulevard, and then acquired the rights to other theaters in Vancouver in Chicago in New York. The company went public in Canada in May of 1993. Now reported income by 1995 was a spectrum ocular $18 million, allowing the company to become dual listed on the NASDAQ stock exchange in the US on the strength of those 1995. Results live that raised another $35 million by issuing new shares into the US at over $9 a share things were looking really good for the company at this point. And in fact their auditors, Deloitte and Touche, were also clearly writing the live in story as well.

Things look so good that in 1995, the audit engagement partner left the firm to become the CFO of live and now things began to unravel in 1996, the theatrical productions were not doing all that well at the box office and something had to be done to bolster financial results. So Dubinsky began to pursue new sources of non theatrical revenues by selling sponsorships to future productions. This diversification of the revenue stream Still helped to offset some of the operational weakness allowing the company to report earnings of $14 million in 1996. However, in 1997, the plot thick into further because 120 $5 million debt offering was in the works and the financial results were obviously paramount to being successful in that endeavor. the now infamous air rights above the penthouse Theatre in Toronto were so far reported $7.4 million, a transaction that even the auditors dug into in question heavily.

Dubinsky was appalled that the auditors had the audacity to push back. Dubinsky solicited to other accounting opinions that supported his desire to report these as revenue in the second quarter of 1997. he in fact even threatened to replace the auditors unless they changed out the entire audit team. The auditors actually conceded to this Demand unwilling to part ways with this prestigious client. This act though broke building skepticism around live event and its accounting policies. Despite having a new audit team, there were still lots of doubts being cast within the various offices of the auditor. The US partners were gravely concerned by the lack of evidence being gathered by their Canadian counterparts to support recognizing these aright revenues in the financial statements.

One partner was adamant that the Canadian partners position was flawed and quote, would not withstand the scrutiny of a professional skeptical challenge. The Canadian engagement partner, however, remained unpersuaded and instead chose to accept that the deal had been reached because of the quote, level of sophistication, business acumen and negotiating skills of Dubinsky and Gotland. In other words, the auditors official stats seemed to be saying that it was sufficient to rely solely on written and verbal representations from in house executives, including that of their own former partner, one had to presume that there was a considerable amount of peer and client pressure to want to believe that the client was telling the truth to the auditors. The Canadian partner went on to be bold enough to state in the fall and I quote, if we were not prepared to accept such representation, it would seem that we should resign as auditors as we effectively would be questioning the fundamental integrity of our client.

This quote certainly highlights the extent to which the auditors found themselves mistaking what ought to be for what is in 2016. The Appeals judge wrote in his ruling that even with the change in the audit teams, Deloitte was clearly aware that livens management was more than merely pushing the envelope from a gap perspective and seem to be turning a blind eye to the warning signs. I also rather liked This poetic passage that the Appeals judge wrote, in 1997, the seeds of trouble took root. And unfortunately, Deloitte continued to mistake the weeds for flowers. When a little digging in its own exercise of professional skepticism obligation, and the application of its accumulated audit knowledge would have revealed the underlying rot. The roots of ethical decay were well planted.

By this time, it would seem in the third quarter of 1997, the auditors conceded to the will of management and permitted those air right revenues to be recorded in income. Even after learning that management had misrepresented this issue not only to the auditors, but to the audit committee and their own investors in their press release. The company's theatrical woes continued by 1998 and a new investor had to be brought in investing another $20 million and he brought with him however, new auditors KPMG KPMG immediately recognized the signs of ethical decay at live and indicating that something wasn't right. And in August of 1998, the CFO and four other managers went to the new man and blew the whistle on Dubinsky and Gottlieb. The ethical decay in this store was not limited to a few characters. It was widespread both across the management team and the auditors who were seemingly turning a blind eye to those warning signals.

By November of 1998, livan actually declared bankruptcy and the KPMG report restated the net income results for the period 1996 to 1998, resulting in a write off of an additional $98 million of previously reported income. The stock price fell from $6 and 75 cents a share to 28 cents almost immediately. In the end, after all the investigations working pleated it was discovered that Verbinski and gantlet had engaged in fraud from the day they had purchased the company from Cineplex Odeon. In the early days. The fraud was a kickback scheme with a couple of suppliers who submitted inflated invoices for the construction of the theaters. While they acted on their own in the beginning to sustain the frauds other employees had to be brought in.

The fraud escalated when the accountants were instructed to begin capitalizing operating costs to the balance sheet to prop up financial results for the IPO. And then those working in it were brought in to reprogram the IT systems to enable the accounting staff to override the accounting systems. Internally management called this the expense roll. Because they would take the transactions reported in one period, make them magically disappear and roll them into another quarter without any hint of an adjustment. And by 1997, the frauds reached epic proportions with the fraudulent rubber New recognition from the sponsorships and the air rights agreements dubinski and Gottlieb were actively misleading not only their own auditors but their own board of directors and investors. fraud in and of itself is hard for auditors to detect.

And in fact, the judge has exonerated Deloitte and Touche from the frauds of 1996 and prior, what was harder to ignore, though, was that the audit staff had failed to execute its own audit program, and in doing so, mistakenly accepted whatever they were told by management, simple execution of basic audit procedures would have illuminated the malfeasance going on. However, the auditors failed to obtain and review the budgets as planned. They accepted management's estimates as to what the potential revenue for any one show would be. In other words, auditing by conversation, they also failed to test the accuracy of estimates against historical experience, which had they done so would have cast significant doubt on the accuracy of these estimates. In 1996 alone, the $14 million of earnings got restated and became a loss of $20 million. After all, this evidence was reexamined.

So as is often the case, when we deal with ethical lapses, the implications are far reaching. As for the main characters in 2009, Drew Pinsky and Gottlieb were both convicted of fraud and forgery and were sentenced to six and seven years, respectively. The unwitting CFO and former Deloitte and Touche partner was fine $7,500 and suspended for two years in Canada was sanctions still pending from the US. The Institute of Chartered Accountants found three individual auditors guilty of professional misconduct and hit them with hundreds of thousands of dollars in fines and legal costs after the longest hearing in the institute's history after over a decade. In the court systems in April of 2014, Deloitte and Touche was successfully sued by the receivers of the company and order to pay $85 million. This ruling was appealed by the defendant, and the ruling was upheld by the Ontario Court of Appeal in January of 2016.

However, there is still an outstanding appeal in process with the Supreme Court of Canada because of the implications this case is having on the auditing profession in Canada today. Not to get into the details of why this case has been so fervently defended. But the implications will be that the auditors duty of care and liability will be broadened as a result of this ruling. So the point is that this ethical case actually has the potential to change the law under which auditors are responsible for compliance. Now, just after Jen and I finished researching this story, this little flyer appeared in our inbox Understanding skepticism was on the agenda of the CPA, Canada national one conference. And obviously, it's one of the most important issues confronting the audit and finance profession today.

But better still, who is moderating and speaking on the panel? Well, none other than representatives from Deloitte itself. I looked at Jen, Jen looked at me, and you know what we had to do? Yep, we did it. Jen. And I flew 4000 miles to get to the end and the bottom of this story and check up on our friends at Deloitte and not once again, I don't say this to to rub their noses in this case, but more so to really give us a credible ending to what has been learned and how they've adapted in the wake of the live and ruling.

And here is what we found out. Let's have a listen. And this is going back to the cases you've probably heard from alive in case Susan ever seen it. Coming out of the judgment, it said that The otters now have a much greater exposure to a broader class of financial stakeholders. And this paved the path for increased auditor liability. How have the firm's more Markman perspective, from a professional skepticism?

Like how have you changed your approach, things have evolved quite a bit since then. And I think that part of the way it's been addressed has been in the robustness in some of the auditing standards and things that I've changed over the years. A lot more focus on the controls, and, you know, dealing with management and audit committees and, and the like. But that said, even with the standards back doesn't get us all the way there for my judgment, professional skepticism standpoint. So I think over the years, we've tried to build up a culture where the more junior staff on patrons are encouraged to speak up. We're trying to develop in a very robust consultation network within our firm.

So bringing experts that have seen things maybe not exactly segment alignment issues. But have you seen things in practice and you can try to connect the dots for people? So we've tried to build up the network within our firm to to challenge from a quality perspective in response to the prevalence and the opportunity for fraud broadly, is that you know, we we have been drafted into into number of audits, more significant specialists in the area of the work, right, people who have spent time in helping companies and that's just what I've seen a lot of things specifically related to fraud. So that's why the audit committee presentations they used to say to me, and then there's a small suite of specialists that come along with me, right and, and part of that is a response to industry issues, experience just having those those folks to go to and I think that's probably a lot more robust than it was, say 21 years ago, when So again, we haven't included this video to condemn Deloitte because they are by no means the only firm do have gone through cases such as this all the big four and many of the national firms have had similar sorts of live event type cases that they've had to work their way through.

The point is, is that we can all learn from these stories and avoid making similar mistakes, and continually improve the quality of the audit without necessarily just jacking up our time budgets and our fees that get charged to unsympathetic clients. What was interesting from this video, though, however, is that the role of elevating our ethical intelligence was not mentioned at all. And in fact, the Chartered Accountants of Scotland have made this connection between auditing and skepticism. With ethics. They've inserted language into gas that uses the words moral courage to describe professional skepticism. The Scottish To find moral courage as to exhibit fortitude, determination, and to exert professional skepticism to challenge others who are behaving inappropriately, and to resist the exploitation of professional opportunity for private benefit rather than public interest.

This is a much better linkage between how auditors exercise professional skepticism, using their ethical intelligence. There are also lessons in the live in story for managers who under extreme pressure of the powerful executives of Gottlieb injure Pinsky forced them to commit acts that enabled this fraud to go on unfettered for nine years. The forces of ethical decay that you learned about in this course are real, and they can't be pervasive. You must find the moral courage to do the right thing, even when everything and everyone around you is doing something else.