Do Hedge Fund Investors Have Standing to Bring Direct, As Opposed to Derivative, Claims against the Auditor of a Hedge Fund Whose Manager Overvalued Portfolios Securities?

On November 8, 2013, reversing an earlier decision of the U.S. District Court for the Southern District of New York (SDNY), the U.S. Court of Appeals for the Second Circuit (Second Circuit) allowed investors to proceed in their federal securities fraud lawsuit against accounting firm PricewaterhouseCoopers LLP (PwC) and its former client, Lipper Convertibles, L.P. (Lipper or the fund), a now defunct hedge fund.  The investor-plaintiffs alleged that PwC overlooked red flags when it audited the fund from 1996 to 2000, resulting in auditor opinion letters that fraudulently induced the plaintiffs to invest in Lipper at inflated prices set forth in financial statements and reports reviewed by PwC.  The SDNY previously dismissed the suit, holding that the investors lacked standing to sue because their claims were derivative, rather than direct, meaning that they had not shown injuries separate from harm to the fund.  See “U.S. District Court Holds That Hedge Fund Investors Do Not Have Standing to Bring a Direct, As Opposed to Derivative, Claim against Hedge Fund Auditor PricewaterhouseCoopers LLP,” Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010).  The Second Circuit reversed, arguing that there were triable issues of fact critical to the determination of whether the investors suffered harm separate from that suffered by other Lipper investors.  This article summarizes the factual and procedural background of the case as well as the Second Circuit’s reasoning in allowing the plaintiffs to proceed to trial.  See also, “When Can Hedge Fund Investors Bring Suit Against a Service Provider for Services Performed on Behalf of the Fund?,” Hedge Fund Law Report, Vol. 6, No. 18 (May 2, 2013); and “Massachusetts Appeals Court Holds That Hedge Fund Investors Can Sue Hedge Fund Auditor Based on Payment of Taxes on Fraudulent ‘Phantom Income,’” Hedge Fund Law Report, Vol. 6, No. 34 (Aug. 29, 2013).

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