Al Rosen Opinion

SCC abandons investors, part III: Livent’s public offering prospectus

The SCC says auditors are not liable for prospectus statements. What does that mean for investors?

Author: Al Rosen

TORONTO – Securities legislation and public accounting practice in 1997 required that a letter of consent be provided for a public offering whenever audited financial statements of prior years are to be incorporated into a prospectus. In this, my third of three columns for Canadian Accountant on the Supreme Court of Canada (SCC) decision on Deloitte & Touche v. Livent Inc. (Receiver of), we look at the SCC decision on Deloitte’s conduct on Livent’s public offering, which Livent lost, 7-0. 

Our concern is whether the SCC decision may deeply weaken securities law for investor purposes. According to the facts of the case, Deloitte helped prepare, and approved, a press release in September 1997, and a “comfort letter,” in support of the prospectus for a US$125 million debenture underwriting (public offering) for the purchase of air rights and adjacent land around Livent’s Pantages theatre. 

In its reasoning process, (paragraph 55) the Supreme Court 4-3 majority, presumably when addressing the financing of the public offering, stated: “Simply put, Deloitte never undertook, in preparing the Comfort Letter, to assist Livent’s shareholders in overseeing management; it cannot therefore be held liable for failing to take reasonable care to assist such oversight.” 

Strange indeed. Why refer to the impractical annual audit concept of “overseeing management?” Why “Livent’s shareholders” as opposed to including the new buyers, arising from the public offering’s prospectus? Why would securities legislation and practice have long required a consent letter for reprinting the 1996 statements unless investors wanted to analyze several years of financial history? 

Could financial conditions have changed during 1997? Yes. Could Livent have deceived oncoming shareholders if the auditors’ consent had been misleading? Yes. 

Does the SCC decision obscure the fundamental distinction between an annual audit versus the extensive, multi-year financial disclosures that are required for a public offering? If so, securities as well as companies legislation has to be updated quickly by lawmakers. The SCC distinctions between an annual audit and a public offering prospectus seem confused. 

The SCC decision denied roughly $44 million of Livent’s prospectus claim, before interest, against the auditors: “… will turn on whether the plaintiff had a right to rely on the [auditors] for … solicitation of investment” purposes (paragraph 55). What does “solicitation of investment” mean? The prospectus’ “right to rely” is deeply inherent in the document’s purpose and should be an obvious, clear “yes”; that is what the legislation specifies. 

In 1997, when Livent filed its public offering, securities legislation called for inclusion of multiple years of past financial statements. Thus the 1996 annual audited financial statements (for which the auditors’ report was later curiously retracted) were required by securities law. An auditor’s “consent letter” was essential as part of the package. 

A consent letter would typically be separate and certainly be in addition to an annual audit. Livent thus had to rely on Deloitte to provide the essential, compulsory consent. Yet, the SCC oddly refers to “overseeing management,” seemingly an SCC annual audit construct, clearly separate from securities requirements. But the intentions of the prospectus’ readers were obvious — to buy or not to buy the offered securities. 

Drafting a consent letter becomes complex when financial conditions have changed since the date on the auditors’ report for 1996. Section 7100 of the auditors’ CICA Handbook at the relevant dates required that auditors of any financial statements in a prospectus address subsequent events (such as those for 1996 in Livent). Paragraph 7100.45 of the CICA Handbook, for example, states: 

“The auditor should perform limited enquiry and review procedures designed to determine whether management has identified events that may require an adjustment to, or disclosure in, the audited financial statements in the prospectus. The period covered by these procedures should extend from the date of the auditor’s report in the prospectus to a date as close to the date of his consent as is reasonable and practicable.” 

The “comfort letter” from Livent’s auditors was dated October 10, 1997, which was after doubts about the then reliability of the 1996 financial statements in an October 1997 prospectus should have been resolved: 

•  Whether Livent was still a going concern in October 1997, (with sufficient cash and liquidity) as had been assumed for the 1996 financial statements (within the traditional one year look-ahead period);
•  dubious capitalization of operating expenses to the balance sheet and other topics, raised for years including in 1996, by various analysts;
•  corporate ownership concerns, which was a reason for requiring the prospectus, as well as any accrual of disputed profits, such as the air rights issue, which was a major 1997 annual audit concern; and
•  then current management integrity issues, including whatever was asserted by directors and was relied upon during the 1996 audit process, and discussed at length by the auditors.

The SCC decision states, “Simply put, Deloitte never undertook, in preparing the Comfort Letter, to assist Livent’s shareholders in overseeing management” (emphasis added). Why is the SCC’s inappropriately assumed annual audit “overseeing management” concept relevant here? The SCC decision ignored prospective investors as well as Canadian Securities legislation. 

Is the SCC suggesting that it is not obvious to auditors that investors could very well lose their money because of seriously outdated 1996 financial misstatements in Livent’s prospectus? If so, it’s shocking news for investors.  

The Supreme Court’s decision must not be allowed to rewrite Canadian securities law. It is based on obsolete concepts of financial reporting and inadequate prospectus and stock market research. Without new legislation, Canada will surely suffer. 

The views and opinions expressed by contributing writers to Canadian Accountant are their own. Canadian Accountant and its parent company bear no responsibility for the accuracy and opinions of contributing writers.  

Dr. Al Rosen, FCA, FCMA, FCPA, CFE, CIP and Mark Rosen, MBA, CFA, CFE, provide independent, forensic accounting investment research. They are the co-authors of Easy Prey Investors: Why Broken Safety Nets Threaten Your Wealth. Learn more at Accountability Research Corporation and Rosen & Associates Limited.

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