CILP ASSOCIATES, L.P., COHEN POOLED ASSETS L.P., ANDREW E. LEWIN, individually and as Trustee of the Regina Gruss Trust f/b/o Andrew Lewin, CLEMENT LEWIN, as Trustee of the Regina Gruss Trust f/b/o Andrew Lewin and in individual capacity and derivatively on behalf of Lipper Convertibles, L.P., MARINA LEWIN, in individual capacity and derivatively on behalf of Lipper Convertibles, L.P., Plaintiffs-Appellants,
PRICEWATERHOUSE COOPERS LLP, Defendant-Cross-Defendant-Cross-Claimant-Appellee, LIPPER CONVERTIBLES, L.P., LIPPER HOLDINGS, LLC, LIPPER & COMPANY, L.P., KENNETH LIPPER, ABRAHAM BIDERMAN, Defendants-Cross-Defendants.
Argued: February 6, 2013
This appeal arises from the collapse of the hedge fund Lipper Convertibles, L.P. The plaintiffs appeal from the District Court's grant of summary judgment on their claims against Lipper Convertibles' auditor PricewaterhouseCoopers LLP ("PwC"), under Section 10(b) of the Securities Exchange Act of 1934 and for fraud and negligent misrepresentation under New York law. For the Section 10(b) claims only, we conclude that there is a triable issue of fact as to whether the plaintiffs suffered a direct injury at the time of their investment by purchasing their interests in Lipper Convertibles at fraudulently inflated prices. Accordingly, we AFFIRM the District Court's judgment dismissing the plaintffs' state law claims, VACATE its dismissal of the plaintiffs' Section 10(b) claims, and REMAND to the District Court to consider in the first instance PwC's scienter argument and for further proceedings.
DANIEL W. KRASNER(Eric B. Levine, Gregory M. Nespole, Stephen H. Orel, on the brief), Wolf Haldenstein Adler Freeman & Herz LLP, New York, NY, for Plaintiffs- Appellants.
J. PETER COLL, JR. (Steven J. Fink, on the brief), Orrick, Herrington & Sutcliffe LLP, New York, NY, for Defendant-Cross- Defendant-Cross-Claimant-Appellee.
Before: KEARSE and LOHIER, Circuit Judges, and KAPLAN, District Judge. [*]
LOHIER, Circuit Judge
This appeal arises from the collapse of the hedge fund Lipper Convertibles, L.P. The plaintiffs appeal from the District Court's grant of summary judgment on their federal claims against Lipper Convertibles' auditor, PricewaterhouseCoopers LLP ("PwC"), under Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), as well as their state law claims of fraud and negligent misrepresentation. With respect to the Section 10(b) claims, we conclude that there is a genuine dispute as to whether the plaintiffs suffered a direct injury at the time of investment by purchasing their shares in Lipper Convertibles funds at fraudulently inflated prices. Accordingly, we VACATE the grant of summary judgment on the Section 10(b) claims and REMAND to the District Court to consider in the first instance PwC's scienter argument and for further proceedings. As for the state law claims, we AFFIRM.
On appeal of a grant of summary judgment in favor of PwC, "we construe the evidence in the light most favorable to the Plaintiffs, drawing all reasonable inferences and resolving all ambiguities in their favor." Gould v. Winstar Commc'ns, Inc., 692 F.3d 148, 151 (2d Cir. 2012) (brackets and quotation marks omitted).
At all relevant times Lipper Convertibles (to which we sometimes refer as the "Fund") was a hedge fund organized as two New York limited partnerships managed by a general partner, Lipper Holdings, LLC, pursuant to a partnership agreement. Under the agreement, the Fund's limited partners did not acquire direct ownership of the securities in which Lipper Convertibles invested. Instead, each limited partner contributed capital entitling it to a share of the Fund's profits and losses. After a limited partner invested, its capital account with the Fund would be debited and credited with proportionate shares of the partnership's profits, losses, and expenses. Each limited partner's initial percentage ownership interest in the Fund was calculated by taking the value of that limited partner's cash contribution and dividing it by the total stated value of all existing partners' capital accounts.
A significant portion of the securities in which Lipper Convertibles invested on behalf of the partnership consisted of convertible preferred stocks and convertible bonds that traded over-the-counter and for which there were no publicly available valuations. According to the plaintiffs' expert report submitted at summary judgment, Lipper Convertibles was to determine the fair value of the Fund's securities based on available "market quotations . . . in the form of bid and asked price quotes from broker-dealers or from Bloomberg." Edward Strafaci, the Fund's principal trader,  was responsible for valuing the Fund's securities at all relevant times.
For fiscal years 1996 through 2000, Lipper Convertibles retained PwC as its outside auditor to review the year-end financial statements that detailed the Fund's performance and the value of each limited partner's interest, and to confirm that the statements were accurate and conformed with Generally Accepted Accounting Principles ("GAAP"). See Continental Cas. Co. v. PricewaterhouseCoopers, LLP, 15 N.Y.3d 264, 267 (2010). Each year, PwC issued an audit letter opining that the financial statements "present fairly, in all material respects, the financial position of Lipper Convertibles, L.P." in conformity with GAAP and that its audit complied with Generally Accepted Auditing Standards.
Two different groups of plaintiffs purchased interests in Lipper Convertibles as limited partners. Collectively, these plaintiffs invested a total of $8, 765, 806 in the Fund through five separate investments on various days between May 1998 and April 2001.
In January 2002 Strafaci abruptly left Lipper Convertibles. In February 2002 Lipper Convertibles issued a letter to its limited partners announcing that it would be revaluing the securities in which it had invested in the wake of Strafaci's "unexpected" departure and after an internal review indicated that "a more cautious valuation was warranted." The letter warned that Lipper Convertibles anticipated reducing its portfolio valuation by approximately 40 percent. The following month, March 2002, Lipper Convertibles announced that the portfolio valuation had in fact declined by approximately 45 percent during the calendar year 2001, and that Lipper Convertibles would be immediately dissolved and the remaining assets distributed to the limited partners according to an established distribution plan.
1. The BDO Reports
Following the announcement, Lipper Convertibles retained an accounting firm, BDO Seidman, LLP ("BDO"), to determine a methodology for the distribution of Lipper Convertibles' assets upon its dissolution. BDO issued an initial report (the "BDO Report") in October 2002 and a follow-up report – with variances not relevant to this appeal – in December 2003. At the outset, the BDO Report cautioned that BDO "ha[d] not been asked to develop an opinion regarding whether the values of the securities contemporaneously reported in [Lipper Convertibles'] records were appropriate at any specific point in time." The report then proceeded to revalue Lipper Convertibles' securities on a month- by-month retrospective basis from January 1995 to November 2001 at prices lower than those contemporaneously reported by Lipper Convertibles. Joint App'x at 1686-87. The alternative values listed in the report were calculated based on securities pricing information provided by independent pricing services associated with the Financial Times Group and Merrill Lynch, as well as on brokerage statements from third-party brokers reflecting their contemporaneously reported pricing of certain of the securities.
In justifying the revaluations, the BDO Report explained that it was "fair and reasonable to obtain and utilize securities market prices [from 1995 through 2001] from the same types of reputable third party sources relied upon by [its] professionals when auditing hedge funds, " Joint App'x at 1687, and that BDO had "employed a reasonable methodology of determining the investors' ownership interests in percentages and dollars as of June 30, 2002, without significant use of the 'market values' of the securities reported" in the records for the fund vehicles in which the plaintiffs had invested, Joint App'x at 1687. BDO calculated revised values for the hedge fund's total capital as well as each limited partner's ownership interest. Having determined that the fair value of the underlying securities had been overstated, BDO also concluded that there had been an overstatement of the Fund's total capital as well as the interests of the limited partners. Accordingly, for ...