On November 13, 2007, U.S. District Court Judge Jane J. Boyle declined to certify a 10b-5 class and granted defendants’ motion for summary judgment on Section 11 claims in the Flowserve securities matter. In particular, Judge Boyle found that plaintiffs had failed to show loss causation, while the Section 11 defendants had shown the absence of loss causation.
In 2001 and 2002 offering documents for Flowserve equity offerings contained financial results that were restated in 2004. Plaintiffs alleged that two Flowserve announcements about its financial performance in 2002 were corrective, even though they did not reveal the need to restate historical results.
Gibson, Dunn & Crutcher, counsel for Flowserve’s auditor, retained Cornerstone Research to provide consulting analysis and to support Professor Christopher James of the University of Florida in his analysis of plaintiffs’ Section 11 claims. Professor James performed an extensive event study and found that no stock price declines during the relevant period could be causally linked to the restatement. His analysis of the public mix of information surrounding plaintiffs’ alleged corrective disclosures in 2002 showed that the market had made no connection between those Flowserve press releases and the accounting allegations at issue. To the contrary, analyst reports pointed to industry-related reasons for the decline. Professor James also showed that the 2004 disclosures regarding the need to restate the historical financial results at issue were not considered by investors to be material. In other words, those disclosures did not cause shareholder losses.
Judge Boyle contrasted plaintiffs’ and defendants’ loss causation analyses:
Plaintiffs stumble in showing the alleged fraud actually affected the market.…Defendants, on the other hand, present admissible evidence, grounded in public data, that decidedly rebuts the fraud-on-the-market presumption.…The Court finds Defendants’ event studies and review of analyst commentary particularly persuasive.…Despite close inspection of these [analyst] reports, James found no reference to a possible restatement of Flowserve’s historical financials, nor any mention of questions regarding the accuracy of Flowserve’s historical financial results.
The Court was particularly critical of the “true financial condition” theory put forth by plaintiffs’ expert Bjorn Steinholt:
Plaintiffs’ expert [Mr. Steinholt] leads the Court to a dangerous precipice. Under his logic, the relatedness tests set forth in Dura and Greenberg are optional. Rather than follow precedent, a plaintiff, like here, with debatable evidence of fraud can pick the largest stock drop irrespective of the actual reason and still relate the fraud because the stock drop is nevertheless a revelation of the company’s true financial health. The “true financial condition” theory, if accepted, threatens to undermine the objective of securities law and disregards precedent…Allowing Plaintiffs to proceed under this theory leads to what the Dura Court expressly proscribed: an insurance policy for investors.