Dura Rides Again

Judge Lewis A. Kaplan (S.D.N.Y.), who enters an impressive third Nugget appearance in two weeks, bravely takes on multiple motions to dismiss in the Net Asset Value ("NAV") actions involving several hedge funds. A hedge fund is no different than any other fund, at least with respect to the fact that one of the most important measures of its success or failure is its value. For many funds, value is an easy metric to evaluate. However, in the case of these hedge funds, the securities they owned were not traded on any exchange, so valuing them "was not a matter of looking up closing prices in the Wall Street Journal." Instead, it was a matter of "judgment." We’re headed for trouble now, aren’t we? Yep, you guessed it. There's a lawsuit involved here. Basically, Plaintiffs (who were shareholders and or limited partners of the funds) sued defendants for overstating their value (again, called NAV), neglecting to use independent valuations, and misrepresenting that the NAV’s were calculated in good faith.

There’s lots of details in this case you may want to check out, but the main item of interest here is the discussion of the loss causation issue under Dura (oh, and the court accepted the group pleading doctrine too in case yuo wanted to know). But let’s stick to loss causation. The court began by citing to Dura, and noting that "if a purchaser sold his investment in the Funds before the truth about NAVs became known, the alleged misstatements would not have caused his losses." The court then analyzed the various fraudulent schemes advanced by Plaintiffs, and held that "plaintiffs adequately allege that defendants materially overstated NAVs and concealed losses from April through September 2002, that plaintiffs purchased securities at inflated prices in reliance upon the misrepresentations, and that plaintiffs were injured when the overvaluation -- the subject of the alleged misrepresentations -- was revealed."

Judge Kaplan also weighed Defendants argument "that there can be no loss causation because plaintiffs' losses supposedly were caused by a drop in interest rates," and "investors… [who] held short positions in U.S. Treasury securities lost money during the summer of 2002 when interest rates fell." But he rejected this position, finding that "this assertion, even if true, would not necessarily explain all of the Funds' losses," and again because "plaintiffs' allegations suggest that defendants delayed in revealing the decline in the Funds' NAV." The judge observed that "even if a decline in interest rates prompted that decline, defendants' failure to disclose the decline on a timely basis caused injury to investors who purchased at inflated prices and were injured when the decline was revealed."

Finally, Judge Kaplan recognized that "plaintiffs adequately plead loss causation for the second and third categories of misstatements -- that the Beacon Hill Defendants promised to value the securities in good faith and/or using independent prices" because "they assert that the Beacon Hill Defendants misrepresented that the Funds' NAVs were calculated in good faith and/or using repo prices, that the NAVs instead were based on the defendants' own valuations, that defendants' valuations fraudulently concealed losses, that plaintiffs purchased at inflated prices in reliance upon the misrepresentations, and that plaintiffs were injured when the losses were disclosed, a disclosure that caused the Funds' collapse." Based on this, he found that "these allegations are sufficient to show that the subject matter of the alleged misrepresentations -- that prices would be valued in good faith and using independent prices -- caused plaintiffs' losses."

You can read the decision at 2005 U.S. Dist. LEXIS 13094.

Nugget: "Although Dura was a fraud-on-the-market case, its reasoning is equally applicable here. The Court based its ruling in part on the fact that ‘the logical link between the inflated share purchase price and any later economic loss is not invariably strong . . . . If, say, the purchaser sells the shares quickly before the relevant truth begins to leak out, the misrepresentation will not have led to any loss.’ The same is true here. If a purchaser sold his investment in the Funds before the truth about NAVs became known, the alleged misstatements would not have caused his losses."