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5th Circ. Revives Flowserve Investors’ Fraud Claims

June 22, 2009
New York
© 2009 Law360

Faulting the lower court’s standard for loss causation, a federal appeals court has breathed new life into a putative class action alleging Flowserve Corp., as well as the company’s underwriters and auditors, defrauded investors with false financial reports.

On Friday, Judges Sandra Day O’Connor, on hiatus from retirement, Jacques Wiener and Carl Stewart of the U.S. Court of Appeals for the Fifth Circuit vacated the lower court’s denial of class certification and reversed the decision to dismiss the fraud allegations against Flowserve, Banc of America Securities LLC, Credit Suisse First Boston LLC and PricewaterhouseCoopers LLP.

The district court erroneously concluded that the plaintiffs — Alaska Electrical Pension Fund and Massachusetts State Carpenters Pension Fund — failed to prove that Flowserve’s restatement of overly sanguine earnings caused the investors’ losses, according to the opinion.

The U.S. District Court for the Northern District of Texas applied an improper standard of proof that required the plaintiffs to show that Flowserve’s corrective statements specifically revealed a fraud, the Fifth Circuit said, and subsequently erred in denying class certification and snuffing out the suit.

“If such a ‘fact-for-fact’ disclosure were required to establish loss causation, a defendant could defeat liability by refusing to admit the falsity of prior misstatements,” the appeals court said.

The district court also failed to adequately determine which of the valve and pump manufacturer’s statements merely confirmed known information, and which are actionable, according to the opinion.

While loss causation cannot be imputed from a general impression in the market of a company's distress, the plaintiffs have a new shot at establishing that the losses were caused expressly by Flowserve’s misstatements pertaining to past financials, acquisition synergies and debt-covenant compliance, according to the opinion.

“To be successful, a securities class action plaintiff must thread the eye of a needle made smaller and smaller over the years by judicial decree and congressional action. Those ever higher hurdles are not, however, intended to prevent viable securities actions from being brought,” the appeals court said.

Sanford Svetcov, counsel for the plaintiffs and a partner at Coughlin Stoia Geller Rudman & Robbins LLP, applauded the decision.

"Plaintiffs are obviously pleased that the Fifth Circuit agreed with us that there is no fact-for-fact or mirror-image test for proving loss causation, and therefore reversed the order denying class cert and vacated the grant of summary judgment to defs. that were based on that test," Svetcov said.

Flowserve said in a regulatory filing Monday: “The company continues to believe that the lawsuit is without merit and that it has strong defenses to the case, and will continue to vigorously defend the case.”

While the appeals court reversed the grant of summary judgment on the plaintiffs Exchange Act claims, it vacated the grant of summary judgment on the Securities Act claims, noting that further proceedings could clarify the defendants' varying culpability for allegedly making stock offerings under defective registration statements.

After Flowserve downwardly revised its 2002 guidance and acknowledged understating its losses by 600 percent, the plaintiffs filed suit in August 2003 alleging violations of the Securities and Exchange Act and the Securities Act.

The plaintiffs are represented by Coughlin Stoia Geller Rudman & Robbins LLP.

Flowserve is represented by Haynes & Boone LLP.

The case is Alaska Electrical Pension Fund et al v. Flowserve Corp. et al, case number 07-11303, in the U.S. Court of Appeals for the Fifth Circuit.

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