By Chad Bray (WSJ)

Private Capital Management LP co-founder Bruce Sherman has sued Bear Stearns Cos., its former chief executive James Cayne and others for allegedly overstating the value of Bear’s mortgage-backed and asset-backed securities and the quality of its risk management before its collapse last year.

The lawsuit, filed Thursday in U.S. District Court in Manhattan, alleges that Mr. Cayne and others at Bear made material misrepresentations about the company’s financial health and its risk management, causing Mr. Sherman to hold shares of Bear stock he “would otherwise have sold months before Bear ultimately collapsed.”

Mr. Sherman, as PCM’s chief executive and chief investment officer, had at one time investment control over about 5.9% of Bear’s outstanding shares, according to the lawsuit. He fully exited his Bear position on March 19, 2008, suffering substantial losses. He retired from PCM earlier this year.

“Defendants knew that the market and the financial press would view Sherman’s sale of his Bear stock as a loss of confidence in Bear by a well-known and long-standing investor,” the lawsuit said. “This, in turn, would have undermined confidence in Bear’s management at a critical time when Bear’s liquidity and Bear’s valuation of its assets were open to question following the implosion of two Bear-sponsored hedge funds in the summer of 2007.”

Mr. Cayne; Warren Spector, Bear Stearns’s former co-president and chief operating officer; Bear Stearns; and its outside auditor Deloitte & Touche are defendants in the case.

Bear Stearns was forced to sell itself to J.P. Morgan Chase & Co. fter being pushed to the brink of failure because of a liquidity crunch in March 2008.

Shareholders approved the sale of the 85-year-old investment house to J.P. Morgan Chase for just $1 billion in May 2008. Bear Stearns had a market value of $20 billion in January 2008.