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Continental Casualty Co. v. PricewaterhouseCoopers

June 29, 2010

CONTINENTAL CASUALTY COMPANY, ET AL., APPELLANTS,
v.
PRICEWATERHOUSECOOPERS, LLP, RESPONDENT.
EAGLE PARTNERS, L.P., ET AL., APPELLANTS,
v.
PRICEWATERHOUSECOOPERS, LLP, RESPONDENT.
JEREMY M. JONES, ET AL., APPELLANTS,
v.
PRICEWATERHOUSECOOPERS, LLP, RESPONDENT.



The opinion of the court was delivered by: Pigott, J.

This opinion is uncorrected and subject to revision before publication in the New York Reports.

In these actions, plaintiffs, former limited partners of Lipper Convertibles, LP, assert direct claims of fraud against PricewaterhouseCoopers, LLP (PwC), the auditor of Lipper Convertibles' annual financial statements for the years 1995 through 2000. Plaintiffs claim that PwC fraudulently declared the partnership's financial statements to be accurate and prepared in conformity with generally accepted accounting principles (GAAP), when in fact they were not. Plaintiffs argue that they were induced by PwC's fraud into making their initial investments in the partnership. But because PwC showed that the damages plaintiffs claimed to have suffered was the result of the conduct of the fund and not a direct diminution of plaintiffs' initial investments, the order of the Appellate Division granting PwC's motion for summary judgment dismissing the fraud cause of action should be affirmed.

Factual Background

Lipper Convertibles (the Fund) was a private investment hedge fund managed by Lipper Holdings, LLC, a Delaware limited liability company, for the benefit of limited partners who were passive investors in the Fund. In general, pursuant to a partnership agreement, limited partners of the Fund held interests equal to their initial investment amounts plus (or minus) any gains (or losses) resulting from the partnership's investment activities. For its duties as manager, Lipper Holdings received 20% of the net profits purportedly received by the Fund. During the relevant time period, PwC was the Fund's auditor, reviewing the financial statements that detailed the Fund's performance and the value of each partner's interest.

Between 1997 and 2001, plaintiffs collectively invested more than $120 million to purchase limited partnership interests.

Plaintiffs claim that they made these investments in justifiable reliance upon the representations about the Fund's operations and performance in the financial statements audited by PwC. The financial statements and reports, which showed consistent growth in the value of the Fund's portfolio, however, fraudulently overstated the Fund's assets by many millions of dollars.

In 2002, the fraud was publicly disclosed after the Fund's portfolio manager unexpectedly resigned. Lipper Holdings, as General Partner, conducted a review of its portfolio and discovered that its manager had used an improper method for valuing the Fund's securities, materially overstating the value of the holdings. The former manager was later investigated by the Securities and Exchange Commission (SEC) and criminally prosecuted, resulting in a guilty plea to securities fraud. PwC's accountant in charge of conducting the audits of the financial statements was ultimately suspended by the SEC for his failings. The SEC found that the representations by PwC - that it had conducted audits that complied with GAAP - were materially false and that its approval of the certification of the Fund's financial statements was "highly unreasonable."

The result of the improper valuation methods was that Lipper Convertibles had, over the years, reported increasingly inflated assets, capital and profits. In February 2002, after completing a reevaluation, Lipper Convertibles announced to its limited partners, including plaintiffs, that it had reduced its assessment of its net equity value by approximately $400 million, a 40% "write down" in its previously reported capital. This resulted in the withdrawals of many limited partners' investments, and the decision that Lipper Convertibles be liquidated. A proceeding to dissolve the Fund was commenced. The General Partner retained an accounting firm, BDO Seidman, to determine a methodology for the distribution of the assets. The plan developed by BDO Seidman involved revaluing the assets of the Fund, on a month-by-month retrospective basis, and then recalculating the existing limited partners' percentage interests for the purpose of the distribution.

In October 2002, a formal liquidation proceeding was commenced to allow the General Partner to distribute the assets to the limited partners in accordance with the BDO Seidman plan. After some litigation not relevant here, the plan was implemented and plaintiffs collectively recovered about $111.5 million.

In the spring of 2003, a Trustee was appointed, charged with, among other things, investigating and bringing claims against the former Fund managers, and any other culpable parties, on behalf of the limited partners who lost money as a result of the Fund's collapse. In July 2004, the Trustee commenced an action against PwC for damages allegedly caused to the Fund by PwC's improper audits. The Trustee alleged, among other things, that PwC was aware of the misstatements in the financial reports, but failed to bring them to the attention of the Fund's management, instead falsely representing that the financial statements were prepared in accordance with GAAP. Based on these allegations, the Trustee asserted causes of action for accountant malpractice, fraud, breach of fiduciary duty and breach of contract.*fn1

The Instant Actions

At the end of 2003, plaintiffs commenced these three separate actions against PwC. Each action asserted claims of fraud, aiding and abetting fraud, aiding and abetting breach of fiduciary duty, negligent misrepresentation, and negligence. For their fraud cause of action, plaintiffs allege that PwC induced them to invest in the Fund through the year-end statements, as well as monthly reports, without having employed the proper auditing methods necessary to ensure that the financial statements were accurate.

PwC moved, pursuant to CPLR 3211, to dismiss the fraud claim, arguing that plaintiffs had pleaded no injury distinct from the injury attributed to the Fund as a whole, which was the subject of the Trustee action that had been brought on behalf of, and would inure to the benefit of, all injured limited partners. PwC argued that plaintiffs' action should be dismissed because it alleged only a derivative injury or, alternatively, should be stayed pending resolution of the Trustee's action. Plaintiffs responded by asserting that their claim was distinct from the Trustee's claim because they were seeking damages predicated on fraud in the inducement -- that they had been fraudulently induced to rely on PwC's audits when they made their initial investment in the Fund and thus sustained injury on the very day of their purchase. They contrasted this injury with the damages the Trustee sought to recover, which included recovery for excessive management and incentive fees the Fund had paid as a result of the overvaluation.

Supreme Court denied, in part, PwC's motion to dismiss. As relevant to this appeal, the court held that "to the extent plaintiffs assert direct claims, such as fraud in the inducement in their initial investment in the Partnership, they are ...


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