Judge Berman’s cogent opinion in Cayvest Global Mandate Inc., v. Lewis Asset Management Corp (PDF),10 Civ. 695 (S.D.N.Y.) demonstrates the high hurdles a plaintiff faces in making out a securities fraud claim under the Private Securities Litigation Reform Act of 1995 (PSLRA).

Plaintiff Cayvest invested $1.9 million in the Defendants’ fund.  Cayvest was told by Defendants that its investment would be no more than 1% of the fund’s total investments, that Cayvest could redeem its investment within thirty days, and that the law firm of Seward & Kissel was the fund’s legal advisor. Sadly for Cayvest, none of that turned out to be true.  Its investment totaled 72% of the fund’s assets, not 1%, and after two years of trying Cayvest still could not redeem its investment.  It also turned out that Seward & Kissel never represented the fund.  

Although those unfortunate circumstances may support state law claims, Judge Berman held that they don’t sufficiently allege scienter under the PSLRA.

First, the mere fact that Cayvest was unable to redeem its investment did not show that Defendants knew that their statement that investments could be redeemed within thirty days was false when it was made, because “a competing inference rationally drawn from the facts alleged is that Defendants may have intended to honor the contract at the outset but, thereafter, did not have the ability to do so.” 

But, what about the Defendants’ statement to Cayvest that Cayvest’s investment would only equal 1% of the fund assets?  “[I]t cannot be concluded that this “forward-looking” proposition involved scienter or recklessness at the time the statement was made… [because a] competing (non-fraudulent) inference is that Defendants were unable to drum up as many investors as they originally, and perhaps over-optimistically, intended.”

And the misstatement about Seward & Kissel?  Judge Berman found no evidence that Cayvest’s losses had anything to do with misrepresentations concerning the fund’s legal counsel, so Cayvest did not meet the “loss causation” standard for securities fraud claims.  Cayvest’s other allegations regarding management’s conflicts of interest fared no better because conflicts of interest do not “standing alone, evidence fraud…”

In the end, Cayvest was sent packing to state court, but left behind a useful lesson from Judge Berman on PSLRA’s high pleading hurdles.