Case Title: Continental Casualty Company v. Pricewaterhouse Coopers, LLP / Eagle Partners, L. P. v. Pricewaterhouse Coopers, LLP / Jeremy M. Jones v. Pricewaterhouse Coopers, LLP

Citation: 

Docket Number: 

State: new-york

Court: New York Appellate Court

Date: 2010-06-29T00:00:00Z

Document:
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This opinion is uncorrected and subject to revision before
publication in the New York Reports.
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No. 133  
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.
Steven J. Ahmuty, Jr., for appellants.
J. Peter Coll, Jr., for respondent.
PIGOTT, J.:
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
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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. 
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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
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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
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No. 133
1  The Trustee settled with PwC in January 2010.
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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.1 
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
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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 not
derivative and the court therefore declines to dismiss them."
Discovery ensued.  Each party presented an expert to
address the extent of any distinct, non-derivative injury
plaintiffs may have suffered.  At the conclusion of discovery,
PwC moved for summary judgment asserting, once again, that
plaintiffs could not come forward with proof that they suffered
an injury distinct from that suffered by the Fund, which damages
were being pursued by the Trustee on behalf of plaintiffs and all
other limited partners.  In support of the motion, PwC submitted
the affidavit of an expert economist who opined that all of the
damages articulated by plaintiffs were derivative as they
consisted only of plaintiffs' pro rata share, as limited
partners, of the Fund's losses arising from (1) net income loss,
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(2) overpayments of general partner fees, and (3) overpayments of
capital to withdrawn limited partners.
In opposition, plaintiffs submitted the affidavit of
their own accounting expert, who argued that because the Fund had
been overvalued at the time of the plaintiffs’ investment, the
damages plaintiffs suffered should be calculated as "the
difference between their initial investments and the amount they
actually recovered through withdrawals or distributions from [the
Fund], plus an appropriate amount of prejudgment interest."  The
expert concluded that the total shortfall among all the
plaintiffs was approximately $35 million and claimed that
plaintiffs would recover far less from the Fund in the
then-pending liquidation proceeding.
Supreme Court granted PwC's motion for summary judgment
finding that plaintiffs failed to present evidence of a direct
injury, noting that plaintiffs had shown only derivative
injuries.  The court held that PwC had made a prima facie showing
that plaintiffs' claims "all state derivative claims that all
limited partners share equally proportionate with their
investments in the Funds . . . [and] none of the [plaintiffs’]
claimed “direct” injuries are independent of any alleged injury
to the Partnerships."  Addressing plaintiffs' evidence, the court
held that plaintiffs failed to carry their burden to respond to
PwC's prima facie showing with competent evidence:
"[D]iscovery is now closed and plaintiffs
fail to produce any evidence to support their
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claim that they suffered a direct injury at
the time of their investments that is
distinct from the injury to the Partnerships
. . . In short, the only loss plaintiffs can
demonstrate is the diminution in value of
their investment in the Partnerships,
stemming from the Partnerships' overpayments
and trading losses.  Thus, the nature of the
injury is derivative.  As plaintiffs fail to
rebut PwC's prima facie showing, the court is
constrained to grant PwC's motions for
summary judgment dismissing the complaints." 
The Appellate Division affirmed(57 AD3d 411).  This
Court granted plaintiffs leave to appeal and we now affirm.
Analysis
Neither party disputes that plaintiffs, as limited
partners of a partnership, may assert a direct claim of fraud in
the inducement.  Indeed, PwC concedes that an individual investor
may have a direct claim for an investment made in reliance on a
fraud.  Thus, for purposes of this appeal, we assume, without
deciding, that plaintiffs properly alleged such a cause of action
against PwC.  The dispute on this appeal then is whether
plaintiffs came forward with proof to refute PwC's showing that
all the damages claimed under that cause of action was
plaintiffs' share of partnership losses and thus derivative in
nature.
In a fraud action, a plaintiff may recover only the
actual pecuniary loss sustained as a direct result of the wrong
(Reno v Bull, 226 NY 546 [1919]).  Under this rule, the actual
loss sustained as a direct result of fraud that induces an
investment is the "difference between the value of the bargain
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which a plaintiff was induced by fraud to make and the amount or
value of the consideration exacted as the price of the bargain"
(Sager v Friedman, 270 NY 472, 481 [1936]).  The damages are to
compensate plaintiffs for what they lost because of the fraud,
not for what they might have gained (see Lama Holding Co. v Smith
Barney, 88 NY2d 413, 421 [1996]).  
Plaintiffs rely on an exception to the fraud damages
rule recognized by this Court in Hotaling v Leach & Co. (247 NY
84 [1928]).  In that case, the plaintiff was fraudulently induced
into purchasing a bond for a certain sum of money (id. at 85-86). 
The trial court measured the damages by deducting from the price
paid, plus interest from the date of payment, the value of the
bond at the time of its sale (id. at 87).  This Court held that
this was the proper measure of damages, as plaintiff was entitled
to recover from the defendants the loss proximately resulting
from the fraud that induced the investment (id. at 87, 92-93).
The Court recognized, however, that this measure of damages was
an exception to the general rule that "the actual pecuniary loss
sustained as a direct result of fraud which induces a purchase .
. . is the difference between the amount paid and the value of
the article received" (id. at 87-88).
Hotaling, however, differs from this case in
significant ways.  First, the Court in Hotaling rejected a
measure of damages based on the market value of the bond when the
plaintiff purchased it, explaining that such value could not be
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determined and would have left the plaintiff without any remedy
(id. at 89).  Here, in contrast, plaintiffs could have come
forward with portfolio valuations showing the amount of the
claimed overvaluation of the portfolio on the day of their
respective investments.  Indeed, plaintiffs' expert acknowledged
that such an analysis could be undertaken, but he failed to do
one, and BDO Seidman undertook a similar calculation in relation
to the liquidation proceeding.  Further, there was no overlapping
derivative claim in Hotaling that would inure to the plaintiff's
benefit.  Here, the Trustee has prosecuted claims seeking the
very same categories of damages allegedly suffered by plaintiffs. 
The presence of the overlapping claims requires plaintiffs to
come forward with direct, distinct date-of-investment injuries. 
Plaintiffs failed to meet their burden.  The only
injury they seek to establish is the diminution in value of their
limited partnership interests at liquidation.  However, that
diminution is attributable to their pro rata share of the
partnership's losses after the date of their investments, and
they experienced those losses in their capacities as limited
partners in common with all other limited partners.  Plaintiffs
cannot recover their pro rata share of the partnership injury and
also recover that same injury under the direct fraud action.  
Thus, PwC was entitled to summary judgment dismissing the fraud
cause of action.
Accordingly, the order of the Appellate Division should
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be affirmed with costs.

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Continental Casualty, et al. v PricewaterhouseCoopers, LLP
No. 133 
READ, J. (DISSENTING):
The issue on defendant PricewaterhouseCoopers, LLP
(PwC)'s motion for summary judgment is whether plaintiffs,
limited partners of Lipper Convertibles, LP (the fund) suffered
any injuries as a result of PwC's allegedly fraudulently inducing
them to invest in the fund which were not derivative in nature --
not whether plaintiffs have advanced the proper measure of
damages for such direct injuries.  Here, there is evidence in the
record that plaintiffs suffered date-of-investment injuries
unique to each of them.  PwC has not shown otherwise, as it must
to succeed in a motion for summary judgment to dismiss the
complaint; all PwC attempted to demonstrate is that plaintiffs'
proposed method of calculating damages for their date-of-
investment injuries, based on plaintiffs' interpretation of our
decision in Hotaling v Leach & Co. (247 NY 84 [1928]),
encompasses after-date-of-investment losses for which the trustee
in liquidation has sought recompense on behalf of the fund. 
Accordingly, I respectfully dissent.
First, the record is replete with evidence that the
fund's investment assets were spuriously inflated during the
years when plaintiffs made individual cash contributions.  This
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overvaluation was, of course, the fraud at the heart of all the
litigation that followed upon the heels of its discovery in early
2002.  Indeed, the fund's principal trader ultimately pleaded
guilty to criminal violations of federal securities laws for
causing the value of the fund's assets to be overstated by
hundreds of millions of dollars.  
Second, there is no dispute that each plaintiff's
initial percentage ownership interest in the fund was calculated
by taking the value of that plaintiff's cash contribution and
dividing it by the total stated value of all existing limited
partners' capital accounts.  As a matter of mathematics, since
the stated value of the capital accounts of the existing limited
partners was artificially inflated -- and, again, it is
undisputed that this was generally the case throughout the
relevant time period -- the relative percentage ownership
interest of each plaintiff's investment in the fund was
necessarily understated on the day it was made.  Or, as
plaintiffs' expert put it, because of the overvaluation,
plaintiffs "'overpaid' for their limited partnership interests in
the Fund at the time of their investment.  On the date of
purchase, each acquired a limited partnership interest that
represented a smaller percentage of the total partners' capital
in the Fund than would have been expected had the Fund's then-
reported market value and value of partners' capital been stated
accurately."
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In light of this evidence, to succeed in a motion for
summary judgment PwC would have to have shown that the values
contemporaneously reported in the fund's records were, in fact,
appropriate at the specific point in time when these plaintiffs
(or at least some of them) made cash contributions.  PwC did not
do this; therefore, PwC did not fulfill its initial burden to
establish that plaintiffs could not prove unique date-of-
investment injuries.
The parties concede that it is feasible for an expert
to determine the true (or at least a more accurate) value for the
fund's investment assets at any moment in time from the beginning
of 1996 through the end of 2001.  Indeed, the majority, in common
with PwC, faults plaintiffs for neglecting to "show[] the amount
of the claimed overvaluation of the portfolio on the day of their
respective investments" (majority op at 10).  I agree that
plaintiffs would have to do this at trial because, as the
majority implicitly holds by distinguishing Hotaling, the proper
measure of damages in this case for fraudulent inducement, if
proven, would be the difference between what plaintiffs paid for
their partnership interest when they invested and the value of
what they received at that time in exchange.  I cannot agree,
however, that, in order to avoid summary judgment, plaintiffs had
to produce evidence of the amount of their damages for direct
injuries whose existence PwC did not refute.  As plaintiffs
pointed out, even if the Court rejects Hotaling's measure of
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damages under these facts, as it has, "[s]ummary judgment does
not require conclusive proof or quantification; it requires only
sufficient evidence to create a genuine issue."  Here, absent the
kind of showing that PwC did not make, there is, at a minimum, a
genuine issue as to whether plaintiffs suffered date-of-
investment injuries.
*   *   *   *   *   *   *   *   *   *   *   *   *   *   *   *   *
Order affirmed, with costs.  Opinion by Judge Pigott.  Judges
Ciparick, Graffeo, Smith and Jones concur.  Judge Read dissents
in an opinion.  Chief Judge Lippman took no part.
Decided June 29, 2010