Lancer Investors Target Bank of America

They allege 'egregious misconduct' in the hedge fund's collapse.
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Investors in Michael Lauer's bankrupt

Lancer Group

hedge funds have sued

Bank of America

(BAC) - Get Report

,

Citco Fund Services

and

PricewaterhouseCoopers

, claiming the prime broker, administrator and auditor of their $570 million investment should have known about the manager's massive fraud and told them about it.

A suit filed in the U.S. District Court for the Southern District of Florida on behalf of the University of Montreal Pension Plan and 88 other investors said the service providers, and several outside directors who ran Lauer's on- and offshore fund, were party to "egregious misconduct and recklessness" that "lost virtually all of plaintiffs' money."

Lancer, which once claimed to have $1 billion in assets, filed for bankruptcy last April after investors sued the funds, saying their asset values were inflated. In July, the

Securities and Exchange Commission

froze Lancer's assets, saying Lauer "manipulated the month-end prices of certain securities held by the funds to overstate the value in the funds' holdings in virtually worthless companies."

Bruce Cowen, a Lancer managing director, last August pleaded guilty to conspiring to commit securities fraud and manipulating the price of a stock owned by his funds. He was snared in a federal investigation into south Florida securities fraud dubbed "Operation Bermuda Short."

The Lancer funds are now in receivership and a court-appointed lawyer is sifting through their wreckage, but it appears little if any money remains.

Scott Berman, a lawyer with Brown Rudnick Berlack Israels, which filed the suit Thursday night, said the defendants knew Lancer was headed for trouble.

"It's a massive hedge fund fraud where people lost hundreds of millions of dollars with the complicity of their third-party service providers," he said. "This is being brought to recoup their investments."

The suit accuses Lauer and the defendants of investing in virtually worthless penny stocks, often buying controlling stakes, then painting the tape at the end of the month by buying a few shares at higher prices. Lancer then calculated its holdings at the higher price and told investors -- which included pop star Britney Spears and disgraced former Sotheby's chairman A. Alfred Taubman -- their funds were still making money.

"The fraud would not have succeeded without the reckless and negligent conduct of the funds' service providers, including their administrators, auditor and prime broker/custodian," the suit said.

The suit claims PricewaterhouseCoopers' Netherlands Antilles offices, which audited the funds, approved and helped distribute false reports. "PWC NA failed to disclose that, in fact, it was simply rubber-stamping the information received from Lauer, thus facilitating the fraud being perpetrated upon the investors."

A manager in PwC's Curacao office, who refused to give her name, said the firm could not comment on the suit.

The suit also accuses Citco Fund Services and Citco employees Anthony Stocks, Kieran Conroy and Declan Quilligan of partial responsibility in the massive collapse. The three men serve as outside directors of the Lancer fund and were responsible for making sure its valuations were correct.

Citco's Curacao office did not return a call seeking comment, and neither Conroy nor Quilligan returned calls from the company's Dublin offices. Stocks no longer works for the fund administrator, which is one of the largest fund services companies in the world.

A spokeswoman for Bank of America Securities in San Francisco said the bank had not had adequate time to study the complaint and would reserve comment.

The legal strategy used by Berman has been tried before with mixed success, notably in litigation surrounding the collapse of the Manhattan Investment Fund, in which investors lost more than $400 million between 1996 and 1999 as manager Michael Berger falsified statements as he shorted technology stocks until the fund imploded.

Investors sued

Bear Stearns

(BSC)

, the prime broker for the fund, and failed to get any money. They collected $64 million from the auditor, the Bermuda affiliate of Deloitte Touche Tohmatsu, and the administrators, businesses affiliated with Ernst and Young International. Another set of investors settled with the Ernst and Young group for $8.8 million.

Michael Malloy, a partner with the Philadelphia law firm Drinker Biddle & Reath, said the most basic agreements with hedge funds generally keep prime brokers insulated from liability.

"If they're just doing narrowly defined work, like executing trades, and that's what the agreement says, then their responsibilities would not go beyond that," he said.

David Blair, managing director of Customs House, a Dublin company that provides administrative services to offshore hedge funds, said that, in general, third parties may bear more responsibility for the way a manager does business.

"The administrator probably has a higher duty of care than the prime broker, who is merely following trading instructions," he said. "The auditor obviously has a higher standard than that -- they're the last set of audited financials."

He said fund administrators put themselves at risk when they depend too much on their fund manager clients for information about the net asset value and holdings of their funds.

"As an administrator, it's important to be independent," he said. "You have to have controls in place to make sure you don't get involved in these things, although sometimes you can't stop fraud. Now, among administrators, the watchword is independence in everything."