Case3:03-cv-01769 Document889 Filed 12/07/2007 Page 1 of6securities.stanford.edu/.../2007127_r01t_03CV01769.pdf · ALEXANDER WILLOWE. RADCLIFFE SHIRLEYH. HUANG 100Pine Street, Suite

Case 3:03-cv-01769 Document 889 Filed 12/07/2007 Page 1 of 6

IN THE UNITED STATES DISTRICT COURTFOR THE NORTHERN DISTRICT OF TEXAS

DALLAS DIVISION

JERRY RYAN, On Behalf of Himself And §All Others Similarly Situated, §

Plaintiff, §

V. §

FLOWSERVE CORPORATION, C. §SCOTT GREER, RENEE J. HORNBAKER,§PRICEWATERHOUSECOOPERS, LLP, §BANC OF AMERICA SECURITIES LLC §CREDIT SUISSE FIRST BOSTON LLC §

Defendants. §

CIVIL ACTION NO. 3:03 -CV- I 769-B(Consolidated with 3 :03 -CV- 1827-B;3:03-CV- 1846-B ; 3:03-CV-2079-B)

ECF

MOTION FOR ENTRY OF JUDGMENTIN FAVOR OF DEFENDANTS AND SUPPORTING BRIEF

Flowserve Corporation, C. Scott Greer, Renee J. Hornbaker, Banc of America Securities

LLC, Credit Suisse First Boston LLC, and PricewaterhouseCoopers LLP (collectively,

"Defendants ) hereby request that the Court direct the Clerk of this Court to enter judgment in favor

of the Defendants , pursuant to Fed. R. Civ. P. 58(a), denying all relief requested by Plaintiffs. A

proposed form of such judgment is being provided to the Court contemporaneously herewith. As

grounds for this Motion, Defendants state as follows:

1. In its November 13, 2007 Order this Court ruled on Plaintiffs' Motion for Class

Certification and Defendants' four Motions for Summary Judgment. See Doc. 888. The Court

denied the Motion for Class Certification. Id. at 2, 43. The denial of class certification was based

on the Court's finding that "Plaintiffs cannot demonstrate loss causation on their § 10(b) and Rule

lOb-5 claims. Id. at 2. The Court also granted summary judgment in Defendants' favor on

Plaintiffs' Section 11 and 15 claims, finding that Defendants had established their statutory negative

causation defense by demonstrating that Plaintiffs' alleged losses were not caused by the alleged

misstatements in the November 2001 and April 2002 Registration Statements , and that Plaintiffs

MOTION FORENTRY OF JUDGMENT Page 1


failed to create a genuine issue of material fact as to Defendants' showing. Id. at 42. In light of

these rulings, the Court denied all other dispositive motions as moot. Id. at 43.

2. Based on the Court's analysis and findings supporting the November 13, 2007 Order,

final judgment now should be entered in favor of Defendants on all of Plaintiffs' claims, including

those under Sections 10(b) and 20 and Rule lOb-5. The Court's holding that Plaintiffs cannot

demonstrate loss causation , an essential element under Section 10(b) and Rule lOb-5, not only

supports denial of class certification, but also is dispositive of Plaintiffs' Section 10(b) claims on the

merits as a matter of law. See McKowan Lowe & Co., Ltd. v. Jasmine, LTD., 2005 U.S. Dist.

LEXIS 32164, at * 33-35 (D.N.J. June 30, 2005) (granting summary judgment on Section 10(b)

claims because of absence of evidence that alleged misrepresentations caused the plaintiffs'

purported loss), aff'd, 2007 U.S. App. LEXIS (3d Cir. Aug. 17, 2007); In re Ikon Office Solutions,

Inc. Sec. Litig., 131 F. Supp. 2d 680, 687-91 (same).'

WHEREFORE, Defendants respectfully request that this Court direct the Clerk to forthwith

prepare and enter a separate document as judgment in this proceeding, in the form submitted

herewith, in favor of Defendants and denying all relief sought by the Plaintiffs.

Dated: December 7, 2007

/s/ Noel M.B. HensleyNoel M.B. HensleyState Bar No. 09491400Carrie L. HuffState Bar No . 10180610

R. Thaddeus Behrens

State Bar No . 24029440

HAYNES AND BOONE, LLP

901 Main Street, Suite 3100

Dallas , Texas 75202-3789

(214) 651-5000

(214) 651-5940 (Facsimile)ATTORNEYS FOR DEFENDANTFLOWSERVE CORPORATION

In their Petition for Permission to Appeal Order Denying Class Certification (Fed. R. Civ. P. 23(f)) filed with theFifth Circuit on November 28, 2007, Plaintiffs themselves note that this Court's November 13, 2007 Order is "likelydispositive of the litigation. See Ex. A to this Motion at 1.



/s/ Todd A. Murray((w/ permission)Fletcher L . YarbroughState Bar No . 22137000Richard A. RohanState Bar No . 17203800Todd A. MurrayState Bar No . 00794350CARRINGTON COLEMAN SLOMAN &BLUMENTHAL L.L.P.901 Main Street, Suite 5500Dallas , Texas 75202214.855.3000214.855 .1333 (Facsimile)

ATTORNEYS FOR DEFENDANT C. SCOTTGREER

/s/ C.W. Flynn (w/ permission)C. W. Flynn, IVState Bar No . 07196580David W. KlaudtState Bar No . 00796073Locke Lord Bissell & Liddell LLP2200 Ross Avenue, Suite 2000Dallas , Texas 75201-6776(214) 740-8000(214) 740-8800 (Facsimile)

ATTORNEYS FOR DEFENDANT RENEEJ.HORNBAKER

/s/ Rodney Acker (w/ permission)Rodney AckerState Bar No. 00830700Ellen SessionsState Bar No. 00796282FULBRIGHT & JAWORSKI L.L.P.2200 Ross Avenue, Suite 2800Dallas , Texas 75201

ATTORNEYS FOR DEFENDANTS BANCOF AMERICA SECURITIES LLC ANDCREDIT SUISSE FIRST BOSTON LLC



/s/ M. Byron Wilder (w/ permission)M. Byron WilderState Bar No. 00786500Joshua P. MartinState Bar No. 24037030Samantha A. FerrisState Bar No. 24050595GIBSON, DUNN & CRUTCHER LLP2100 McKinney Avenue, Suite 1100Dallas, Texas 75201Telephone: (214) 698-3100Facsimile: (214) 571-2900

Dean J. KitchensCA State Bar No . 082096GIBSON, DUNN & CRUTCHER LLP333 South Grand AvenueLos Angeles, California 90071Telephone: (213) 299-7000Facsimile: (213) 229-7520

ATTORNEYS FOR DEFENDANTPRICEWATERHOUSECOOPERS LLP



CERTIFICATE OF CONFERENCE

I hereby certify that on December 7, 2007, I spoke with Ms. Willow Radcliffe, counsel forPlaintiffs, regarding the foregoing Motion. Ms. Radcliffe advised that Plaintiffs deem the Motioninappropriate at this time because of this Court's August 22, 2007 Order Granting Defendants'Emergency Motion to Stay Trial and Pretrial. On that ground, Plaintiffs oppose the Motion.

/s/ Noel M.B. HensleyNoel M.B. Hensley



CERTIFICATE OF SERVICE

I hereby certify that the foregoing was served upon its filing via this Court's CM/ECFsystem on this 7th day of December, 2007 to the individuals listed below:

Joe Kendall C. W. Flynn, IVWillie C. Briscoe David W. KlaudtProvost & Umphrey Law Firm, LLP Locke Lord Bissell & Liddell LLP3232 McKinney Avenue, Suite 700 2200 Ross Avenue, Suite 2000Dallas , Texas 75204 Dallas , Texas 75201-6776

Willow Radcliffe Rodney AckerJeffrey Lawrence Ellen SessionsCoughlin Stoia Geller Fulbright & Jaworski, LLPRudman & Robbins LLP 2200 Ross Avenue, Suite 2800100 Pine Street, Suite 2600 Dallas, TX 75201-2784San Francisco, California 94111

M. Byron WilderFletcher L. Yarbrough Joshua MartinRichard A. Rohan Gibson, Dunn & Crutcher LLPTodd A. Murray 2100 McKinney AvenueCarrington Coleman Sloman Suite 1100& Blumenthal L.L.P. Dallas, TX 75201

901 Main Street, Suite 5500Dallas, Texas 75202

/s/ R. Thaddeus BehrensR. Thaddeus Behrens


Case 3:03-cv-01769 Document 889-2 Filed 12/07/2007 Page 1 of 33

EXHIBIT A


No.

IN THE UNITED STATES COURT OF APPEALSFOR THE FIFTH CIRCUIT

JERRY RYAN, et al.,

Plaintiffs-Petitioners,

vs.

FLOWSERVE CORPORATION , et al.,

Defendants-Respondents.

Appeal from the United States District Courtfor the Northern District of Texas

No. 3:03-CV-01769-BThe Honorable Jane J. Boyle

PLAINTIFFS' PETITION FOR PERMISSION TO APPEAL ORDER DENYINGCLASS CERTIFICATION (FED. R. CIV. P. 23(f))

COUGHLIN STOIA GELLERRUDMAN & ROBBINS LLPSANFORD SVETCOV

JEFFREY W. LAWRENCESUSAN K. ALEXANDERWILLOW E. RADCLIFFESHIRLEY H. HUANG

100 Pine Street, Suite 2600San Francisco, CA 94111Telephone: 415/288-4545

415/288-4534 (fax)

Lead Counsel for Plaintiffs-Petitioners

[Additional counsel appear on signature page.]


JERRY RYAN, et al. v. rLOWSERVE CORPORATION, et al.

Fifth Circuit No.

CERTIFICATE OF INTERESTED PERSONS

Counsel for lead plaintiff Alaska Electrical Pension Fund and named plaintiff

Massachusetts State Carpenters Pension Fund certifies, pursuant to Fifth Cir. R.

28.2.1, that the following listed persons have an interest in the outcome of this case:

A. Defendants and Their Counsel

Flowserve Corporation Renee J. Hornbaker

Noel M.B. Hensley C.W. Flynn, IV

Carrie Lee Huff David W. Klaudt

Nicholas Even Locke Liddell & Sapp, LLP

R. Thaddeus BehrensHaynes & Boone, LLP

C. Scott Greer PricewaterhouseCoopers LLP

Fletcher L. Yarbrough M. Byron Wilder

Richard A. Rohan Joshua P. Martin

Todd A. Murray Samantha A. FerrisCarrington, Coleman, Sloman Dean J. Kitchens

& Blumenthal, L.L.P. Gibson, Dunn & Crutcher LLP

Banc of America Securities LLC Credit Suisse First Boston LLC

Rodney Acker Rodney AckerEllen B. Sessions Ellen B. SessionsFulbright & Jaworski L.L.P. Fulbright & Jaworski L.L.P.

Cl of2


JERRYR YAN, et a 1. v. FL0WSER VE CORPORATION, et a/.

Fifth Circuit No.

B. Lead Plaintiff and Their Counsel C. Additional Named Plaintiff

Alaska Electrical Pension Fund Massachusetts State Carpenters Pension Fund

Patrick J. Coughlin Coughlin Stoia Geller Rudman

Darren J. Robbins & Robbins LLP, and Individual Counsel for

Sanford Svetcov Lead Plaintiff Listed Herein

G. Paul HowesJeffrey W. Lawrence Aaron D. Krakow

Willow E. Radcliffe Krakow, Souris & Birmingham, LLC

Ex Kano S. Sams IISusan K. Alexander James F. Grosso

Shirley H. Huang O'Reilly Grosso & Gross, P.C.Coughlin Stoia Geller Rudman& Robbins LLP

D. Liaison Counsel

Joe KendallWillie C. BriscoeHamilton LindleyProvost Umphrey Law Firm, LLP

LeadTETCOVfor Plaintiffs on Appeal

C2 of2


TABLE OF CONTENTS

Page

1. INTRODUCTION .................................. 1........................................................

II. QUESTION PRESENTED ............................................................................. 3

III. STANDARD OF REVIEW ............................................................................ 3

IV. STATEMENT OF THE CASE ...................................................................... 4

V. DISTRICT COURT RULING...................................................................... 10

VI. REASONS WHY APPEAL SHOULD BE PERMITTED .......................... 12

A. The District Court Manifestly Erred as a Matter of Law inHolding that Loss Causation Can Be Proven Only When theCorrective Disclosures Specifically Identify the FalseStatements , and Not When the Disclosure Reveals theCompany's True Financial Condition that Had Been PreviouslyMisrepresented .................................................................................... 12

Dura Held that to Plead and Prove Loss Causation,Plaintiffs Must Demonstrate that the Stock PriceDeclined upon Revelation of the "True FinancialCondition " Concealed by the Misrepresentations Allegedto Have Inflated the Stock Price . ............................................. 13

2. Neither Greenberg Nor Oscar Require that the

Disclosures Admit the Misstatements Were False, but

Only Require that Disclosures Causing a Decline in

Stock Price Be "Related" to the Misrepresentations ................ 14

3. Under the Fact-for-Fact Test, Defendants Can Immunize

Themselves by Refusing or Delaying Disclosure that

Their Statements Were False or Concealing Them by

Attributing the Company's Negative Performance to

Other Factors ............................................................................ 18

VII. CONCLUSION: RELIEF SOUGHT ............................................................ 20

- i -


TABLE OF AUTHORITIES

CASES

Page

Aldridge v. A. T. Cross Corp.,284 F.3d 72 (1st Cir. 2002) ........................................................................... 19

Chamberlan v. Ford Motor Co.,402 F.3d 952 (9th Cir. 2005) 3..........................................................................

Croker v. Carrier Access Corp.,No. 05-cv-01011-LTB-OES,2006 U.S. Dist. LEXIS 48603 (D. Colo. July 18, 2006) .............................. 17

Dura Pharm., Inc. v. Broudo,

544 U.S. 336 (2005) ............................................................................... passim

Freeland v. Iridium World Commc'ns, Ltd.,

233 F.R.D. 40 (D.D.C. 2006) ........................................................................ 19

Greenberg v. Crossroads Sys., Inc.,

364 F.3d 657 (5th Cir. 2004) ................................................................. passim

In re Bradley Pharm., Inc. Sec. Litig.,

421 F. Supp. 2d 822 (D.N.J. 2006) ............................................................... 12

In re Cabletron Sys., Inc.,

311 F.3d 11 ( 1st Cir. 2002) ........................................................................... 17

In re Daou Sys., Inc.,

411 F.3d 1006 (9th Cir. 2005) .......................................................... 13, 14, 20

In re Monumental Life Ins. Co.,

365 F.3d 408 (5th Cir. 2004) .......................................................................... 3

In re Motorola Sec . Litig.,

505 F. Supp . 2d 501 (N.D. Ill. 2007) ............................................................ 14

- ii -


TABLE OF AUTHORITIES

Page

In re Worlds ofWonder Sec. Litig.,

35 F.3d 1407 (9th Cir. 1994) ........................................................................ 19

Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,259 F.3d 154 (3d Cir. 2001) ........................................................................... 3

Oscar Private Equity Investments v. Allegiance Telecom, Inc.,

487 F.3d 261 (5th Cir. 2007). (Order 24, 27) passim

Prado-Steiman v. Bush,

221 F.3d 1266 (11th Cir. 2000) ...................................................................... 3

Ryan v. Flowserve Corp.,

444 F. Supp. 2d 718 (N.D. Tex. 2006) ................................................... 12, 19

Semerenko v. Cendant Corp.,223 F.3d 165 (3d Cir. 2000) ......................................................................... 20

STATUTES, RULES AND REGULATIONS

15 U.S.C.§77k ................................................................................................................. 9

§77o ................................................................................................................. 9

§78j(b) ............................................................................................................. 9

§78t(a) ............................................................................................................. 9

§78u-4(b)(4) .................................................................................................... 2

Federal Rules of Appellate ProcedureRule 5(c) .......................................................................................................... 4

Federal Rules of Civil ProcedureRule 12(b)(6) ................................................................................................... 5

Rule 23(f) ........................................................................................................ 3

- iii -


1. INTRODUCTION

Interlocutory appeal is warranted here because the district court's order is

manifestly erroneous on a question of law that is likely dispositive of the litigation.

The court held that loss causation can be proven in a securities fraud action only when

the corrective disclosures causing the stock price decline specifically identify' the

earlier-made misstatements alleged and admit they are false, and cannot be proven

indirectly by showing, as contemplated by Dura Pharm., Inc. v. Broudo, 544 U.S. 336

(2005), that the disclosure reveals the true "financial condition" of the company that

had been concealed by the earlier misstatements . Id. at 344.

In this case, Flowserve Corporation's ("Flowserve") July 22 and September 27,

2002 partial disclosures of missed earnings estimates and reduced guidance revealed

to investors that Flowserve's financial condition was not as previously represented -

but defendants did not confess those misrepresentations. The market understood the

economic consequences, though not yet the legal liability of the disclosures, and took

the artificial inflation out of the stock price by 37% and 38% after each disclosure.

(Memorandum Order filed November 13, 2007 ("Order") 6-8, copy attached) As one

analyst stated on July 24, 2002: "the market believes something is fundamentally

wrong with Flowserve's core business." (Docket No. ("Doc.") 610: Steinholt Report

¶60, APP27)


The district court rejected plaintiffs' evidence of loss causation because their

expert relied on the "true financial condition" standard, which the court believed

would allow plaintiffs to prove loss causation without linking the decline in stock

price to the earlier misrepresentations, and would thereby provide an "insurance

policy" for investors contrary to the goals of the securities laws. (Order 23-25) The

court erred in two significant respects.

First, Dura states that the relevant "truth" that must be disclosed is the

company's true "financial condition" that was previously concealed or misrepresented

- not the precise misstatements used to accomplish the fraud. 544 U.S. at 344. Dura

itself imposed this test to avoid any "insurance" issue. Second, proving that the

revelation of true financial condition served to remove all or part of the inflation from

the stock price is not the end of plaintiffs ' burden . As required by Greenberg v.

Crossroads Sys., Inc., 364 F.3d 657, 665 (5th Cir. 2004), plaintiffs must also prove

that the true financial conditions revealed - here, missed earnings estimates - were

"related" to and thus caused in substantialpart by defendants' misrepresentations -

here, overstated historical earnings, and concealed accounting and integration

problems upon which the earnings estimates were predicated. 15 U.S.C. §78u-4(b)(4).

Under the district court's fact-for-fact standard, defendants can immunize themselves

simply by avoiding a confession that their misstatements were false.

-2-


II. QUESTION PRESENTED

Whether the district court made a manifest legal error in denying class

certification by holding that loss causation can only be proven directly by showing

that the corrective disclosures causing a decline in stock price specifically identified

and admitted defendants' alleged false statements, and cannot be proven indirectly by

showing, as contemplated by Dura, that the disclosure reveals the true financial

condition of the company that had been concealed by defendants ' misstatements.

III. STANDARD OF REVIEW

Federal Rule of Civil Procedure 23(f) states: "A court of appeals may in its

discretion permit an appeal from an order of a district court granting or denying class

certification ...." The advisory committee adds that standards for granting review

would be developed by "[t]he courts of appeals ." Fed. R. Civ. P. 23(f) advisory

committee's note. Rule 23(f) interlocutory review is warranted to correct a manifest

error of law. Prado-Steiman v. Bush, 221 F.3d 1266, 1275 (11th Cir. 2000); Newton

v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 259 F.3d 154, 164 (3d Cir. 2001);

Chamberlan v. Ford Motor Co., 402 F.3d 952, 958-59 (9th Cir. 2005). Although an

order denying certification is ordinarily reviewed for abuse of discretion, this Court

reviews de novo "the question whether the district court applied the correct legal

standard ." In re Monumental Life Ins. Co., 365 F.3d 408, 414 (5th Cir. 2004).

-3-


IV. STATEMENT OF THE CASE'

As alleged in the Fifth Amended Complaint ("Complaint" or "Compl."), and

supported by plaintiffs' evidence submitted in support ofclass certification (Doc. 608-

16), the essence of the case against defendants, based on numerous documents, e-

mails, admissions and witnesses, is that they misrepresented Flowserve's financial

results and concealed key information from the market about its internal accounting,

acquisition costs, and debt covenants. The district court listed four categories of

misrepresentations:

• "False Financials" - Flowserve falsely reported financial results in the

fiscal years 2000, 2001, 2002 and the first three quarters of 2003 by

"improperly understating current cost sales expenses, improperly

overstating inventory. . . ." (Compl. ¶129);

• "Optimistic EPS" - Flowserve, through Greer and Hornbaker, falselypredicted a 40%-50% increase in earnings per share ("EPS") for fiscalyear 2002 despite their knowledge of earnings shortfalls. (Compl. ¶6);

• "Dis-synergies" - Flowserve's growth-by-acquisition binge was an ill-conceived plan, particularly concerning its integration of IDP and IFCwhich saddled the company with over $1.1 B in debt. (Compl. ¶4); and

• "Violation ofDebt Covenants" - Flowserve violated its debt covenants

under its "senior credit facilities for three consecutive quarters (3Q01,

Except as otherwise noted, this summary is drawn from and cites to the Orderof the district court, revised and edited to meet the 20-page limit on petitions. Fed. R.App. P. 5(c).

-4-


4Q01 and 1 Q02), namely the `maximum leverage ratio ' and the `interestcoverage ratio ."' (Compl. ¶155).

(Order 9-10) Defendants filed motions to dismiss under Fed. R. Civ. P. 12(b)(6), and

the Private Securities Litigation Reform Act of 1995 ("PSLRA"), which the district

court denied at a hearing on November 18, 2005. (Order 10)

Flowserve manufacturers pumps, seals, and valves, and provides a variety of

flow management services to the "process industries." (Order 3) Flowserve's

financial slide began in fiscal year 2000 when the company "went on a massive

acquisition binge more than doubling its size but saddling itself with immense debt."

(Id.) In particular, the company faced extreme difficulties with its August 2000

acquisition of Ingersoll-Dressor Pump Co. ("IDP"). (Id.) Such difficulties led to

negative cash flow, a need for equity infusion, and violations of Flowserve's debt

covenants. (Id.)

The proposed class period begins on February 6, 2001 with Flowserve' s false

report of $13.2 million in net income for the year 2000. (Id.) Defendants'

overstatement of Flowserve's financial position caused the company's stock to trade

at inflated levels. (Id.) Defendants' continued concealment ofinventory issues, rising

operating costs, eroding earnings, and overall mischaracterization of the company's

financial status, enabled Flowserve's stock price to remain inflated throughout the

-5-


class period. (Id.) Defendants C. Scott Greer, the CEO, and Renee J. Hornbaker, the

CFO - both accountants - issued recklessly unrealistic predictions of earnings. (Id.)

On May 31, 2001, Flowserve filed a Shelf Registration Statement with the

Securities and Exchange Commission ("SEC") that would become the basis for their

November 2001 and April 2002 public offerings. (Order 5) On November 16, 2001,

Flowserve filed a Prospectus Supplement with the SEC and, pursuant to the

November 2d01 Registration Statement, held a public offering of its common stock at

$23.50 per share. (Id.)2 The November 2001 Registration Statement incorporated

Flowserve's 2000 Form 10-K - consisting of, among other things, a "Report of

Management" attesting to the adequacy of Flowserve' s internal controls and

Flowserve's audited 2000 year-end financial statements. (Id.)

On April 16, 2002, Flowserve filed a second Prospectus Supplement with the

SEC, and held a public offering of its common stock at $31.50 per share, pursuant to

the April 2002 Registration Statement . (Order 5-6) This Registration Statement also

incorporated Flowserve's 2000 Form 10-K, as well as Flowserve's 2001 Form 10-K -

again consisting of a "Report of Management" attesting to the adequacy of

2 The November 2001 Prospectus Supplement and the Shelf RegistrationStatement comprised the November 2001 Registration Statement. The April 2002Prospectus Supplement and the Shelf Registration Statement comprised the April2002 Registration Statement. (Order 5 nn.6-7)

-6-


Flowserve's internal controls and Flowserve's audited 2001 year-end financial

statements. (M)

The misstatements at the core ofplaintiffs' claims are contained in Flowserve's

year-end financial statements, unqualified audit reports, and the reports of

management. These misrepresentations inflated the value of Flowserve's stock.

(Order 6) In their testimony in another proceeding, defendants Hornbaker and Greer

admitted problems with the work-in-progress ("WIP") accounting at the Vernon

facility, and other internal accounting deficiencies which, according to Flowserve's

auditor, caused material understatements of costs and overstatement of earnings in

2000 to 2002. (Doc. 609-16, APP407-693; 1152; 1156; 1158-60; 1214)

Plaintiffs alleged and presented evidence, including detailed economic analysis

by damages expert, Bjorn Steinholt, to show that in July and September 2002,

Flowserve issued press releases which revealed the company's "true operating

performance and financial condition" - triggering their losses. (Order 15-16)

After the market closed on July 22, 2002 , Flowserve issued a press release

purportedly explaining missed earnings estimates and lowering guidance:

Results for the second quarter of 2002 primarily reflect weakening in thequick turnaround business, particularly the chemical and industrialsectors, specifically affecting industrial pumps, manual valves andservice.

-7-


"Of particular concern is the deterioration of the quick-ship business inthe chemical and industrial sectors. At the beginning ofthe year, we hadexpected this business to be flat to slightly down for the year. During thesecond quarter, bookings for this sector experienced double-digit year-over-year declines. Considering the importance of this business to ourmargins, this type ofvolume decline coupled with our planned inventoryreductions will make profit improvement difficult. [sic] ... Greer said."

(Order 6-7) The following trading day, Flowserve's stock price declined to $14.55

per share, a 37% decrease from the previous day. (Order 7)

Only two months later, on September 27, 2002, prior to the opening of the

market, Flowserve again lowered its earnings estimates:

Citing market-related factors, Flowserve Corp. (NYSE:FLS) todaylowered its 2002 earnings estimates to 30 to 32 cents for the third quarterand $1.45 to $1.55 for the full year, excluding special items, which relateto the May 2002 acquisition of the Invensys Flow Control Division(IFC). The company's previous guidance had been 38 to 43 cents for thethird quarter and $1.70 to $1.90 for the full year, on the same basis.

These market-related factors include unanticipated further deteriorationoftypically higher margin book-and-ship, or quick turnaround, business,particularly in the chemical, power, and general industrial sectors, and anunfavorable mix of lower margin project business.

(Order 7-8) Flowserve stock closed that day at $8.70 per share , which was another

decline of approximately 38%. (Order 8)

Nearly two years later, on February 3, 2004, Flowserve announced it would

restate its earnings: "[e]stimated restated results for the nine months ended Sept. 30,

2003 and for the full year 2002, 2001 and 2000 include aggregate pretax charges of

approximately $11 million, predominantly to correct inventory and related balances

-8-


which resulted in cost of sales adjustment." (Order 8) That day, the price of

Flowserve's stock declined by only $0.12 to $19.18 per share. (Id.) On April 26,

2004, Flowserve filed its Form 10-K for fiscal year 2002, restating and reducing its

earnings by $23.6 million for 2000 to 2002. (Order 8-9, Compl. ¶355)

Flowserve announced a second restatement of an expected $10 million on

October 26, 2004, but on February 7, 2005 admitted it would be a $20 million

reduction in earnings . (Compl. ¶¶378-79) The actual restatement - $35.9 million -

was not filed until February 13, 2006, resulting in a combined reduction ofnearly $60

million in net income. (Doc. 239 at 8)

Prior to any restatements , on August 7, 2003, plaintiffs filed a complaint against

Flowserve, Greer, and Hornbaker for violation of § 10(b) and §20(a) of the Securities

Exchange Act of 1934. (Order 9) On May 14, 2004, after the first restatement,

plaintiffs added claims against PricewaterhouseCoopers LLP, Flowserve' s auditor,

and Banc of America Securities LLC and Credit Suisse First Boston LLC, who were

among the underwriters for the two public offerings for violation of § 11 and § 15 of

the Securities Act of 1933. After several amendments, the operative pleading is

plaintiffs' Fifth Amended Complaint. (Order 9)

-9-


V. DISTRICT COURT RULING

The district court denied class certification concluding that, based on the

admissible evidence, including conflicting event studies by experts for each party,

plaintiffs failed to carry their burden of proving loss causation . (Order 2, 17) The

court found "no direct revelation" ofthe four categories of false statements alleged in

the 2002 press releases - "A straightforward comparison between the allegations and

the 2002 press releases indicate no credible relation ." (Order 20) "Nowhere in these

alleged corrective disclosures [chemical industry and quick-turn business declines,

missed second quarter earnings estimates, and reduced 2002 earnings guidance] does

the court find any tenable relation, general or specific, to dis-synergies., false

financials , violations of debt covenants , or optimistic EPS." (Order 21, 28)3

The district court rejected the analysis ofplaintiffs' damages expert, because it

was based on the use of the "true financial condition " theory. (Order 23) To

Steinholt, the 2002 earnings miss and reduced guidance were a disclosure of the

"relevant truth" about the "financial condition" ofFlowserve that previously had been

3 In fact, the disclosures ofmissed earnings estimates and reduced guidance relate

directly to "optimistic EPS," as defendants' own expert conceded. (Doc. 716: Allen

Report at 54-55, APP61-62: "[i]t is certainly true that Flowserve's updated guidance

provided an improved insight into the earnings prospects of the Company."

(emphasis added)).

-10-


concealed by defendants' fraudulent conduct, and caused "the resulting price decline."

(Doc. 610 : Steinholt Rebuttal ¶43 , APP 193-94) To Judge Boyle, however, "true

financial condition" is not the correct legal standard under Dura and this Circuit's

decisions in Greenberg, 364 F.3d 657 and Oscar Private Equity Investments v.

Allegiance Telecom, Inc., 487 F.3d 261 (5th Cir. 2007). (Order 24, 27) The court

believed that under the "true financial condition" test, there would be a "windfall" to

1aintiffs because "ifany corporate defendant ever files a restatement, it will virtually

guarantee investors the ability to recoup for any loss." (Order 30)

The court's ruling ignores that, under Dura, 544 U.S. at 344, to prove loss

causation plaintiffs must first prove that the stock price declined upon revelation of

the truth about the company's financial condition that had been previously

misrepresented. Plaintiffs must also prove that the misrepresentations alleged - and

not other non-fraud factors - caused the true financial conditions disclosed and the

ensuing losses when the price declined. Id. Thus, the "windfall" ofthe district court's

"fact-for-fact" test is to defendants, who now have a roadmap for evading liability

unless they choose to admit their earlier false statements. If left uncorrected, the order

sets too high a bar for injured investors, and effectively immunizes wrongdoers. The

fraudsters would hold the keys to the courthouse.

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VI. REASONS WHY APPEAL SHOULD BE PERMITTED

A. The District Court Manifestly Erred as a Matter of Law inHolding that Loss Causation Can Be Proven Only Whenthe Corrective Disclosures Specifically Identify the FalseStatements, and Not When the Disclosure Reveals theCompany's True Financial Condition that Had BeenPreviously Misrepresented

In denying defendants' motion to dismiss, Judge Boyle rejected defendants'

theory that a "direct causal link" had to be established between the disclosure of their

fraud and plaintiffs' loss, which defendants asserted required plaintiffs to plead that a

company's disclosures of the truth revealed "fact for fact" each material fact

previously misrepresented . Ryan v. Flowserve Corp., 444 F. Supp. 2d 718, 724-29

(N.D. Tex. 2006). Judge Boyle understood that under defendants' mirror-image

approach, any corrective disclosure by the company would have to directly reveal the

"precise topics of the alleged misrepresentations," including that "Flowserve's

historical financial statements" were overstated . Id. at 726-27. Judge Boyle cited

numerous district court cases rejecting as "rigid" the demand by defendants for such

explicit and direct corrective disclosures . E.g., In re Bradley Pharm., Inc. Sec. Litig.,

421 F. Supp. 2d 822, 828-29 (D.N.J. 2006).

In denying class certification, however, the district court demanded proof that

the corrective disclosures explicitly alerted market investors that the company's

-12-


historical earnings for 2000-2002 had been overstated. (Order 19-20) As discussed

below, the district court's decision violates Dura, 544 U.S. at 344.

1. Dura Held that to Plead and Prove Loss Causation,Plaintiffs Must Demonstrate that the Stock PriceDeclined upon Revelation of the "True FinancialCondition" Concealed by the MisrepresentationsAlleged to Have Inflated the Stock Price

In Dura, the Supreme Court held that loss occurs not when investors purchase

stock at fraud-inflated prices, but only when "the relevant truth begins to leak out."

Dura, 544 U.S. at 342. But Dura did not confine the "relevant truth" to direct and

explicit identification or admission of the fraudulent misrepresentations or omissions

alleged. Instead, for purposes ofproving loss causation, Dura defined the truth in

terms of the company's financial condition: "[A] person who `misrepresents the

financial condition of a corporation in order to sell its stock' becomes liable to a

relying purchaser `for the loss' the purchaser sustains ` when the facts ... become

generally known ' and `as a result ' share value ' depreciates ."' Id. at 344 (emphasis

added). The Court later reiterated that plaintiffs must plead and prove that the

company's "share price fell significantly after the truth became known." Id. at 347.

The true financial condition analysis in Dura was applied in In re Daou Sys.,

Inc., 411 F.3d 1006 (9th Cir. 2005). In Daou, the company's third-quarter 1998

financial results were dismal leading to a precipitous drop in stock price - from

- 13 -


$18.50 to $3.25 per share. Id. at 1025-26. The district court in Daou held that

plaintiffs' complaint did not link the decline in stock price to any negative disclosures

that defendants engaged in improper revenue recognition . Id. at 1026-27. The Ninth

Circuit reversed, concluding the complaint sufficiently alleged loss causation because

it alleged the stock price fell after defendants began to reveal "the company's true

financial condition," just as the Supreme Court contemplated in Dura. Id. at 1026.

The district court's fact-for-fact proof standard here conflicts with, and is

manifest error, under Dura. The disclosures must reveal the true financial condition

of the company that had been previously misrepresented or concealed by the fraud,

and need not reveal the precise false statements used to carry out the fraud. A "share

price decline following an earnings warning" does "serve as a disclosure in which `the

relevant truth begins to leak out"' even if it does not point "directly to a previous

representation and proclaims its falsity." In re Motorola Sec. Litig., 505 F. Supp. 2d

501, 540, 546 (N.D. Ill. 2007).

2. Neither Greenberg Nor Oscar Require that theDisclosures Admit the Misstatements Were False, butOnly Require that Disclosures Causing a Decline inStock Price Be "Related" to the Misrepresentations

Neither Greenberg nor Oscar holds that corrective disclosures must directly

reveal or admit - fact-for-fact - that the misstatements alleged are false, as the district

-14-


court believed. (Order 24) Indeed, under Dura, 544 U.S. at 344, it was error for the

district court to so construe them.

In Greenberg, decided before Dura, this Court held that "plaintiffs must

demonstrate that there is a reasonable likelihood that the cause of the decline in

[stock] price is due to the revelation of the truth" about earlier false positive

statements, and not to the release of other "unrelated negative information" about the

company. 364 F.3d at 665. Though Greenberg held that plaintiffs failed to prove the

disclosure of product problems were related to a 66% earnings miss, this Court held

that "[n]ews that a company's earnings will be two-thirds short of analysts' estimates

is the type ofnegative information most likely to cause a sharp decline in stock price."

Id. at 669. In Oscar, this Court applied Greenberg and held that plaintiffs must

present "proof that some percentage of the drop was attributable to the corrective

disclosure" through "further analysis" by an expert in the form of "an empirically-

based showing" - e.g., event studies. Oscar, 487 F.3d at 271.

Such "further analysis" was undertaken here by plaintiffs' expert, but contrary

to Oscar, the district court erroneously rejected it because it believed the expert relied

on the wrong legal standard. (Order 23) Under the district court's fact-for-fact test,

no expert analysis as contemplated by Oscar is necessary. Courts need only look at

-15-


the disclosures and if defendants have not admitted the statements alleged were false,

the case is over. Nothing in Greenberg or Oscar contemplates such a result.

Here, not only did experts for both sides agree that the July 22 and September

27, 2002 reduction in Flowserve ' s guidance caused significant stock price declines,

but plaintiffs' expert explained, as required by Greenberg and Oscar, that the earnings

miss disclosures were related to all four categories of the fraudulent statements

alleged because the misrepresentations were all related to the overall financial

performance of Flowserve - its bottom-line-earnings . (Doc. 610: Steinholt Rebuttal

¶¶44-48, APP 194-96) Indeed, Flowserve elsewhere admitted , as the Complaint

alleges, that the company's historical results were related to its future forecasts.

(Compl. ¶355) In Flowserve's October 22, 2001 press release, defendants linked their

40%-50% increased 2002 guidance to its strong (but false) 2001 results. (Compl.

¶¶213, 233) Thus, plaintiffs ' expert here , corroborated by the record , provides the

"further analysis" this Court required (but found absent) in Oscar, 487 F.3d at 271.

In finding that the 2002 disclosures were related to company-specific

misrepresentations and omissions and not just non-fraud industry-wide factors (Doc.

610: Steinholt Rebuttal ¶¶47-48, APP 196-97), plaintiffs' expert relied on event studies

as contemplated by Oscar, not "speculation" as Judge Boyle erroneously concluded.

(Order 24) The expert's findings were not only grounded in the now "common use of

- 16-


basic principles ofeconometrics ," Oscar, 487 F.3d at 271, but were also based on law.

"The reason - indeed, the only sensible reason - why investors would be interested in

the status of [a company's] product development would be to enable them accurately

to assess [the company' s] earnings projections and prospects for future, unprojected

earnings ." Croker v. Carrier Access Corp., No. 05-cv-01011 -LTB-OES, 2006 U.S.

Dist. LEXIS 48603, at *22 (D. Colo. July 18, 2006); see In re Cabletron Sys., Inc.,

311 F.3d 11, 35 (1st Cir. 2002) ("Accurate earnings figures are vital aspects of the

`total mix of information' which investors would consult when evaluating [the

company's] stock.").

In sum, Flowserve's attraction to the market depended on its ability to generate

net income through cost savings even as its revenues remained flat. Defendants

repeatedly and falsely told investors that the "synergies" - i.e. cost savings - the

company had achieved would produce increasing earnings . As a result, the market

focused on Flowserve's "true financial condition" in terms of its earnings . In July and

September 2002, the market learned that Flowserve's current andprojected earnings

were far below estimates, and thus the company's true financial condition was not as

previously represented. Thus, the market learned the impact of the fraud and the

inflation was removed, but the market did not yet know theprecise method- the false

historical financial statements - by which defendants had accomplished the fraud.

- 17-


Thus, Dura, Oscar, and Greenberg, plaintiffs met their burden ofproving loss

causation by proving that: (i) negative partial disclosures ofserious earnings shortfalls

revealed the "true financial condition" ofFlowserve that had been misrepresented by

the fraud (but not the precise manner, i.e. financial misstatements used to carry it

out);4 and (ii) thefinancial misstatements alleged were related to and actually caused,

in whole or in part, the negative true financial condition of the company revealed by

the disclosures, and the ensuing decline in stock price and loss.

3. Under the Fact-for-Fact Test, Defendants CanImmunize Themselves by Refusing or DelayingDisclosure that Their Statements Were False orConcealing Them by Attributing the Company'sNegative Performance to Other Factors

In rejecting fact-for-fact corrective disclosure at the pleading stage, Judge Boyle

recognized that to "impose a requirement in securities fraud cases that each fact

misrepresented be in turn specifically confessed before liability could attach would

discourage candor and inhibit the flow of precise, accurate information between

4 Plaintiffs alleged a consistent theory as to defendants' 2002 press releases,

maintaining that they partially disclosed Flowserve's "true financial condition," but

also did not admit and continued to conceal the full truth about the company's

financial condition. (Compl. ¶¶13, 347-50, 355-56, 456-57) There was no change or

"contradiction" in theory as the district court mistakenly believed. (Order 6 n.8, 20)

-18-


corporations and shareholders." Flowserve Corp., 444 F. Supp. 2d at 729. That is no

less true at summary judgment or trial.

Other courts agree. Requiring mirror-image corrections by defendants of each

misrepresentation in order to plead loss causation would allow wrongdoers to

"immunize themselves" from liability "by refusing to admit their falsity." In re

Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1422 (9th Cir. 1994). Put another way,

"reading Dura to require proof of a complete, corrective disclosure [of prior

misstatements] would allow wrongdoers to immunize themselves with a protracted

series ofpartial disclosures ." Freeland v. Iridium World Commc'ns, Ltd., 233 F.R.D.

40, 47 (D.D.C. 2006). In a related context, the First Circuit has aptly observed that the

fact that a company that engages in "accounting shenanigans" never restated its

financial reports cannot serve to negate scienter:

[T]he fact that the financial statements for the year in question were notrestated does not end Aldridge's case when he has otherwise met thepleading requirements of the PSLRA. To hold otherwise would shift toaccountants the responsibility that belongs to the courts. It would alsoallow officers and directors ofcorporations to exercise an unwarranteddegree ofcontrol over whether they are sued, because they must agreeto a restatement of the financial statements.

Aldridge v. A.T. Cross Corp., 284 F.3d 72, 83 (1st Cir . 2002) (emphasis added).

In requiring fact-for-fact proofof loss causation, Judge Boyle stands the policy

considerations here on their head. As shown above, Dura's "true financial condition"

-19-


standard is not an insurance policy for investors , as. Judge Boyle incorrectly believed.

Plaintiffs still bear a significant burden - proving that defendants' alleged

misrepresentations caused the negative financial conditions revealed.

With the roadmap provided by the district court's "fact-for-fact" direct

relatedness regime, clever fraudsters can immunize themselves simply by refusing to

admit the falsity of their prior statements. Defendants can commit fraud, reveal the

negative financial impacts ofthe fraud on the company, but make it nearly impossible

for plaintiffs to prove loss causation so long as defendants do not reveal how they

accomplished the fraud, or attribute the negative economic impacts entirely to other

causes, some ofwhich may simply be false misdirection. But even if other non-fraud

industry-wide causes cited by the company were true, that still would not defeat loss

causation because plaintiffs may recover when the misrepresentations are a

"substantial cause" of the stock ' s "decline in value ." Semerenko v. Cendant Corp.,

223 F.3d 165, 187 (3d Cir. 2000). A "plaintiff is not required to show `that a

misrepresentation was the sole reason for the investment's decline in value' in order to

establish loss causation ." Daou, 411 F.3d at 1025.

VII. CONCLUSION: RELIEF SOUGHT

For the foregoing reasons, the Court should grant leave to appeal the district

court's Order denying class certification.

-20-


DATED: November 27, 2007 COUGHLIN STOIA GELLERRUDMAN & ROBBINS LLPSANFORD SVETCOVJEFFREY W. LAWRENCESUSAN K. ALEXANDERDENNIS J . HERMANWILLOW E. RADCLIFFESHIRLEY . HUANG

RD SVETCOV

100 Pine Street, Suite 2600San Francisco , CA 94111Telephone: 415/288-4545415/288-4534 (fax)

COUGHLIN STOIA GELLERRUDMAN & ROBBINS LLPEX KANO S. SAMS II9601 Wilshire Blvd., Suite 510Los Angeles, CA 90210Telephone: 310/859-3100310/278-2148 (fax)

COUGHLIN STOIA GELLERRUDMAN & ROBBINS LLP

PATRICK J. COUGHLING. PAUL HOWESANNE L. BOXJAMES R. HAIL655 West Broadway, Suite 1900San Diego, CA 92101Telephone: 619/231-1058619/231-7423 (fax)

Lead Counsel for Plaintiffs- Petitioners

-21-

Case 3 : 03-cv-01769 Document 889-2 Filed 12/07/2007 Page 29 of 33

PROVOST UMPHREY LAW

FIRM, LLPJOE KENDALLState Bar No. 11260700WILLIE C. BRISCOEState Bar No. 24001788HAMILTON LINDLEYState Bar No. 240448383232 McKinney Avenue, Suite 700Dallas, TX 75204Telephone : 214/744-3000214/744-3015 (fax)

Liaison Counsel for Plaintiffs-Petitioners

O'REILLY GROSSO & GROSS, P.C.JAMES F. GROSSO1671 Worcester Road, Suite 205Framingham, MA 01701-5400Telephone: 508/620-0055508/620-7655 (fax)

Additional Counsel for Plaintiffs-Petitioners

T:\CasesSF\ lowserve\BRF00047224.doc

-22-


CERTIFICATE OF COMPLIANCE

As proscribed by Fed. R. App. P. 5(c), this Petition contains 20 pages of text.

SANFORD ] ETCOV

Case 3 : 03-cv-01769 Document 889-2 Filed 12/07/2007 Page 31 of 33

DECLARATION OF SERVICE BY MAIL

I, the undersigned, declare:

1. That declarant is and was, at all times herein mentioned, a citizen of the

United States and employed in the City and County of San Francisco, over the age of

18 years, and not a party to or interested party in the within action; that declarant's

business address is 100 Pine Street, Suite 2600, San Francisco, California 94111.

2. That on November 27, 2007, declarant served the PLAINTIFFS'

PETITION FOR PERMISSION TO APPEAL ORDER DENYING CLASS

CERTIFICATION (FED. R. CIV. P. 23(f)) by depositing a true copy thereof, along

with a pdf version on a virus free disk, in a United States mailbox at San Francisco,

California in a sealed envelope with postage thereon fully prepaid and addressed to

the parties listed on the attached Service List.

3. That there is a regular communication by mail between the place of

mailing and the places so addressed.

I declare under penalty of perjury that the foregoing is true and correct.

Executed this 27th day of November, 2007,,atSan Francisco, Cali

I


Service List - 11/15/2007 (03-0287)

Page 1 of 2

Counsel For Defendant(s)

Fletcher L. YarbroughRichard A- RohanTodd A. Murray

Carrington, Coleman, Sloman & Blumenthal,L.L.P.

901 Main Street, Suite 5500

Dallas, TX 75202

214/855-3000214/855-1333(Fax)

M. Byron Wilder

Gibson Dunn & Crutcher LLP-

2100 McKinney Avenue, Suite 1-1¢--',O'-

Dallas, TX 75201-7390

214/698-3100214/698-3400(Fax)

C.W. FlynnDavid W. Klaudt

Locke, Lord, Bissell & Liddell, LLP

2200 Ross Avenue, Suite 2200

Dallas, TX 75201-6776

214/740-8000214/740-8800 (Fax)

Rodney AckerEllen B. Sessions

Fulbright & Jaworski L.L.P.

2200 Ross Avenue, Suite 2800

Dallas, TX 75201-2784

214/855-8000214/855-8200(Fax)

* Noel M_B. HensleyCarrie Lee Huff

Haynes and Boone, LLP

3100 Nationsbank Plaza, 901 Main Street

Dallas, TX 75202-3789

214/651-5000214/651-5940(Fax)

*Denotes Service of Two Copies.


Service List - 11/15/2007 (03-0287 )

Page 2 of 2

Counsel For Plaintiff(s)

Darren J. Robbins

Coughlin Stoia Geller Rudman & Robbins LLP655 West Broadway, Suite 1900San Diego, CA 92101

619/231-1058619/231-7423(Fax)

Willow E. Radcliffe

Coughlin Stoia Geller Rudman & Robbins LLI

100 Pine Street, Suite 2600San Francisco, CA 94111-5238

415/288-4545415/288-4534(Fax)

James F. Grosso

O'Reilly Grosso & Gross, P.C.

1671 Worcester Road Suite 205

Framingham, MA 01701-5400

508/620-0055508/620-7655(Fax)

John Frith Stewart

Stewart , Roelandt , Stoess, Craigmyle & EmeryPLLC

6506 West Highway 22, P.O . Box 307

Crestwood , KY 40014

502/241-46605021241 -9301 (Fax)

Joe KendallWillie C. BriscoeHamilton P. Lindley

Provost Umphrey Law Firm, LLP

3232 McKinney Avenue, Suite 700

Dallas, TX 75204

214/744-3000

214/744-3015(Fax)

Documents

Case3:03-cv-01769 Document889 Filed 12/07/2007 Page 1 of6securities.stanford.edu/.../2007127_r01t_03CV01769.pdf · ALEXANDER WILLOWE. RADCLIFFE SHIRLEYH. HUANG 100Pine Street, Suite