(CN) - Limited partners in a defunct hedge fund can sue PricewaterhouseCoopers for failing to catch a 40 percent overvaluation of the fund's assets, the 2nd Circuit ruled.
The case involves a March 2002 announcement by hedge fund Lipper Convertible that its portfolio's value was inflated 40 percent, or $1.76 billion, and that the fund would be immediately dissolved, and its assets distributed.
Lipper had commenced the revaluation of its portfolio after principal trader, Edward Strafaci, abruptly departed in January 2002 and an internal review found that "a more cautious valuation was warranted."
Two years after his departure, Strafaci pleaded guilty to securities fraud and acknowledged that there was no formal review within the fund of his valuations, court records show.
"The values that I assigned to the securities were higher because I valued them based on my estimate of what they would be worth at some point in the future," Strafaci testified.
Limited partners sued the fund's accountant, PricewaterhouseCoopers, for confirming the accuracy of Lipper's accounting statements for fiscal years 1996 through 2000.
A federal judge dismissed the lawsuit, however, after finding that the partners lacked standing because they did not suffer any injury distinct from that suffered by the fund itself.
In reviving the suit last week, the 2nd Circuit found that Strafaci's testimony was relevant and telling.
"Strafaci's admission that he overvalued the securities during the period of time that the plaintiffs purchased their interests was sufficient to create a triable issue of fact as to whether the plaintiffs purchased their interests at an inflated price and thereby suffered a direct injury at the time of their investments," Judge Raymond Lohier wrote for the three-judge panel.
And while the plaintiffs could have presented their evidence more clearly, reports by BDO Seidman, the firm hired to distribute the fund's assets, were submitted to the trial court, which revalued Lipper Convertible's securities on a month-by-month retrospective basis.
Given that the reports totaled only 35 pages, "plaintiffs were not asking the District Court 'to peruse a haystack looking for needles,'" the 28-page opinion states.
The reports specifically stated that the firm was not requested to make an opinion whether Lipper correctly valued its securities at any specific point in time.
But "at the summary judgment stage it was irrelevant that the valuations in the report failed to reflect the precise valuations of the securities on the particular purchase dates at issue," Lohier wrote. "Such a level of precision was not required to defeat summary judgment for the simple reason that the amount of overstatement relates to damages, not liability."
The reports' disclaimer notwithstanding, plaintiffs presented a triable issue of fact whether the securities were overvalued at the time of purchase, the panel concluded.
"In the light most favorable to the plaintiffs, we cannot reconcile the BDO Reports with PwC's insistence that the prices at which the plaintiffs purchased their interests remained entirely unaffected by the overvaluations," the ruling states.
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