ryan, et al. v. flowserve corporation, et al. 03-cv-01769...
TRANSCRIPT
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ORIGINAL
UNITED STATES DISTRICT COUR
NORTHERN DISTRICT OF TEXA S
DALLAS DIVISION
JERRY RYAN, On Behalf of Himself and AllOthers Similarly Situated,
Plaintiff,
vs.
FLOWSERVE CORPORATION, et al . ,
Defendants
U.S. DISTRICT COURTNORTHERN DISTRICT OF TEXAS
FILED
DEB2 2
CLERK, U .S. DISTRICT C U TBy
Deput y
Civil Action No . 3 :03-CV-1769-M(Consolidated with 3:03-CV-1827-M; 3 :03-CV-1846-M ; 3 :03-CV-2079-M )
[PROPOSED] FIFTH AMENDED COMPLAINT FOR VIOLATION OF SECTIONS 11AND 15 OF THE SECURITIES ACT OF 1933 AND SECTIONS 10(B) AND 20(A) OF
THE SECURITIES EXCHANGE ACT OF 1934
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TABLE OF CONTENTS
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Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (Defendant sFlowserve, Greer and Hombaker) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1
A. Introduction and Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1
B. Jurisdiction and Venue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
C . The Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 0
D. Background Facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 8
E. Acquisitions Completed Prior to the Class Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 9
F . Witnesses/Sources of Plaintiffs' Allegations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1
G. Greer and Hornbaker Were Each Actively Engaged in the Acquisitio n
Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 0
H. Greer, Hombaker and Flowserve's Knowledge Was Gained, in Part ,
Through Attendance at Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2
1 . Weekly Presidents' Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2
2. Quarterly Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2
3 . Annual Controllers' Meeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 3
4. Weekly, Monthly and Quarterly Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 4
5. Budget Presentation Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
6. Monthly Integration Management Team Meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 5
1. Greer and Hornbaker Insisted upon Preordained Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 5
J . Flowserve's False Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
1 . Flowserve Restates Almost Four Years of Financial Statements . . . . . . . . . . . . . . 39
2. Flowserve Overstated Inventory and Understated Cost of Sales . . . . . . . . . . . . . . . 44
3 . Earnings Management" Through the Improper Employment o f"Cookie Jar" Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
4. Flowserve's Disclosures about Its Debt Covenant ComplianceWere False . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
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5. Flowserve Disguised Recurring Operating Expenses as One-Tim eCharges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
6. Flowserve Knew Its Internal Accounting Controls Wer eInadequate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
7 . Other GAAP Violations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
K. Materially False and Misleading Statements Issued During the Clas sPeriod . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
1 . The lOb-5 Defendants' False and Misleading Statement sConcerning the Company's Year End 2000 Financial Results . . . . . . . . . . . . . . . . . 57
2 . The lOb-5 Defendants' False and Misleading Statement sConcerning the Company's 1Q01 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
3 . The 1Ob-5 Defendants' False and Misleading Statement sConcerning Shelf Registration Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
4 . The lOb-5 Defendants' False and Misleading Statement sConcerning July Amended Prospectus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
5 . The 1Ob-5 Defendants' False and Misleading Statement s
Concerning 2Q01 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
6 . The lob-5 Defendants' False and Misleading Statement sConcerning 3 QO 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
7 . The lOb-5 Defendants' False and Misleading StatementsConcerning FY01 and FY02 EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
8 . The lOb-5 Defendants' False Statements Concerning 3Q0 1Funding and Compliance with Debt Covenants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
9 . The lOb-5 Defendants' False Statements Concerning theNovember Prospectus Supplement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
10 . The lOb-5 Defendants' False and Misleading Statements in the
Year End 2001 Press Release . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
11 . False and Misleading Statements Concerning the Completion o fthe IDP Integration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
12 . The 1Ob-5 Defendants' False and Misleading Statement sConcerning the Year Ending 12/31/01 Financial Statements . . . . . . . . . . . . . . . . . . . . 96
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13. The lOb-5 Defendants' False and Misleading Statement s
Concerning the 2001 Annual Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97
14. The lOb-5 Defendants' False and Misleading Statement sConcerning the April Prospectus Supplement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .102
15. The lOb-5 Defendants' False and Misleading Statement sConcerning I Q02 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .105
L. The lOb-5 Defendants' Scheme Begins to Unravel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
M. Greer and Hombaker Sign Sarbanes-Oxley Certifications Under Oath . . . . . . . . . . . . . . 112
N. Flowserve Begins to Partially Reveal Previously Undisclosed Materia l
Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113
0. Information Released Subsequent to the Class Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 5
P. Applicability of Presumption of Reliance : Fraud-on the-Market Doctrine . . . . . . . . 124
Q. No Safe Harbor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125
II . Violation of Sections 11 and 15 of the Securities Act (Defendants Flowserve ,Greer, Hombaker, PwC, BofA and CSFB) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
A. Jurisdiction and Venue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
B. The Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
C. Liability Under Sections 11 and 15 of the Securities Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130
1 . The Shelf Registration Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 1
2. The 11/16/01 Prospectus Supplement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
3 . The 4/16/02 Prospectus Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136
4. PwC Did Not Conduct Audits in Conformity with GenerallyAccepted Auditing Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
5. BofA's and CSFB's Conflicted Role in the Offerings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 1
6. Post-Offering Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
III . Plaintiffs' Class Action Allegations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
FIRST CLAIM FOR RELIEF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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Violation of Section 10(b) of the Exchange Act and Rule lOb-5 PromulgatedThereunder (Against Flowserve , Greer and Hombaker) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144
SECOND CLAIM FOR RELIEF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147
Violation of Section 20(a) of the Exchange Act (Against Greer and Hornbaker) . . . . . . . . . . . 147
THIRD CLAIM FOR RELIEF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148
Violation of Section I 1 of the Securities Act for the Offering (Against Al lDefendants ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148
FOURTH CLAIM FOR RELIEF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152
Violation of Section 15 of the Secu rities Act (Against Greer and Hornbaker) . . . . . . . . . . . . . . . 152
PRAYER FOR RELIEF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152
JURY TRIAL DEMANDED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
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1 . Sections 10(b) and 20 (a) of the Securities Exchange Act of 1934 (DefendantsFlowserve , Greer and Hornbaker)
A. Introduction and Overview
1 . This securities class action is brought on behalf of persons who purchased th e
publicly traded securities of Flowserve Corporation ("Flowserve" or the "Company") betwee n
2/6/01 and 9/27/02 (the "Class Period "), against : Flowserve; its Chief Executive Officer ("CEO"), C .
Scott Greer ("Greer") ; its Chief Financial Officer ("CFO"), Renee J . Hornbaker ("Hornbaker") ; it s
auditor, P ricewaterhouseCoopers LLP ("PwC") ; and two of the underwriters for Flowserve' s
offerings during the Class Period, for violations of the federal securities laws .
2. Defendants Flowserve, Greer and Hornbaker (the "l Ob-5 Defendants") engaged in a
scheme to defraud shareholders in violation of §§ 10(b) and 20(a) of the Securities Exchange Act of
1934 ("Exchange Act"), 15 U .S.C. § §78j(b) and 78t(a), and Rule IOb-5 promulgated thereunder by
the Securities and Exchange Commission ("SEC"), 17 C .F.R. §240 .10b-5. Greer and Hornbaker's
scheme involved overstating Flowserve's future and historical performance, including inflating
inventory and understating its cost of sales for almost four years . On 4/27/04, Flowsere was forced
to restate its financial statements filed with the SEC for the fiscal years 2000, 2001, 2002 resulting in
a reversal of $23 .6 million of pretax earnings .1 Following Flowserve's announcement of the
restatement, it announced that the SEC is investigating Flowserve's potential fraud in connectio n
with the restatement and with regard to its violation of Regulation FD .
3 . The scheme to defraud Flowserve shareholders was executed by two sophisticate d
executives . Greer and Hornbaker are educated and experienced in corporate financial accounting ,
both being licensed certified public accountants. Prior to the beginning of the Class Period, Greer
and Hornbaker undertook an overly aggressive and poorly executed acquisition binge . To cover up
Flowserve also restated its results for the first three quarters of 2003 .
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their failure to manage the chaos their massive mergers created at Flowserve, Greer and Hornbaker
violated their fiduciary duties as certified public accountants and as Company officers and caused
Flowserve to engage in accounting fraud . As detailed by the 33 confidential witnesses alleged
herein as "CWs" - former Flowserve employees who were in a position to know - Greer an d
Hornbaker were the architects of Flowserve's financial fraud. By understating Flowserve's costs b y
inflating WIP inventory, Greer and Hombaker concealed Flowserve's true financial condition for
close to four years, knowingly issued projections that were impossible to meet, and contradicted
internal data . Concealing Flowserve's dire cash- flow problems and violating its major lenders' loan
covenants afforded Greer and Hombaker the opportunity to seek capital from shareholders . Through
two equity offerings undertaken during the Class Period, and the concomitant restructuring of
Flowserve debt, Greer and Hornbaker's scheme achieved its goal : it bought time and money to bail
Flowserve out of its cash- flow debacle .
4 . Flowserve's growth-by-acquisition strategy left the Company saddled with over $1 . 1
billion of debt and facing extreme difficulties as the integration of the acquired companies into
Flowserve caused "dis-synergies" or inefficiencies . These inefficiencies caused costs to spiral
upwards while, at the same time, the Company lost revenue as orders were not shipped on time or at
all . In addition, follow-on orders were not placed, and customers took their business elsewhere . In
fact, as described by CWs, following the August 2000 acquisition of Ingersoll-Dresser Pump Co .
("IDP"), Flowserve's pump division became consumed with problems building the pumps that were
in the pipeline and became so bogged down with that effort that it was nearly impossible to start
building new pumps until into 2003 . Greer and Hornbaker were repeatedly warned of the
inefficiencies caused by the integration process by the integration management team ("IMT") they
assembled and the consultants they hired . In the face of these warnings, Greer and Hornbaker
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presented a fallaciously rosy picture to the public about the progress of the integration efforts an d
prospects .
5. At the end of fiscal year 2000, the lOb-5 Defendants knew that the cost of sales were
publicly understated and inventory was overstated because they received reports from each division
that documented the inventory problems . Nevertheless, defendants Greer and Hornbaker wer e
determined to ensure that Flowserve reported consistent revenue and earnings gains each quarter -
and repo rt ing increased costs was contrary to this mandate. So , according to CWs, Greer berate d
Flowserve's division managers and finance personnel into reporting results that reflected Greer' s
mandate rather than Flowserve's true financial results . Those who would not comply were fired .
6 . Flowserve, through Greer and Hornbaker, predicted a 40%-50% increase in earnings
per share ("EPS"), excluding special items, for FY02 at the beginning of the Class Period, and
repeated their purposely inflated prediction through April 2002 . Greer and Hornbaker concealed the
revenue and earnings sho rtfalls being reported and required Flowserve 's managers to comply with its
top-down requirement of providing projections that reflected 15% growth each quarter, despite these
managers ' protests . Throughout the Class Period , Flowserve ' s stock remained grossly inflated by
Greer, Hornbaker and Flowserve ' s fraud as illustrated by the chart included in the Proxy Statement
dated 4 /29/04 which compares Flowserve to the S&P 500 and S&P 500 Indust rial Machinery
indices . A true and correct copy is attached hereto as Exhibit ("Ex.") A .
7 . Greer and Hombaker knew that the problems facing the Company, if properl y
disclosed , would have far-reaching and devastating financial consequences for the Company and fo r
defendants Greer and Hornbaker, individually. They knew that Flowserve's violation of its debt
covenants, which required maintenance of interest coverage and maximum leverage ratios, woul d
result in a chain reaction that would terminate the Company's growth-by-acquisition strategy as the
opportunity to seek capital from the equity markets became foreclosed . If the true financia l
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condition of Flowserve was revealed, the cost offinancing Flowserve's cash- flow shortfalls would
be sent through the roof as the banks either called the loans due or required one-time payments,
increased borrowing spreads and required more restrictive financial covenants following
Flowserve's default. In addition, Greer and Hornbaker concealed the true financial condition o f
Flowserve to keep them from being forced to forego hundreds of thousands of dollars in incentive-
based compensation . Indeed, as revealed by the Company's 4/29/04 Proxy Statement, Greer and
Hombaker were precluded from reaping any bonuses for their performance in 2003 due to the
restatement and the revelation of the Company's true financial condition. However, Greer and
Hombaker were not forced to disgorge any of the prior three years of fraudulently obtained incentiv e
bonuses.
8 . Before they were forced to admit Flowserve's true condition, Greer and Hornbaker
filed a Registration Statement and Prospectus dated 5/31/01 and amended 7/2/01 ("the Shel f
Registration") that authorized the issuance of a maximum of $500 million worth of Flowserv e
common stock at a later date . The timing and chosen instrument for issuing additional shares of
Flowserve stock was important to their scheme and illustrates the sophistication and shrewdness of
defendants Greer and Hornbaker . By choosing a Shelf Registration, Flowserve was able to comply
with the initial registration requirements on 7/2/01 while it was not yet in violation of loan
covenants . Greer and Hornbaker knew that Flowserve would soon be in violation of these covenant s
and in danger of default on its credit facilities and due to Flowserve's negative operating cash flo w
in 2001, seeking equity from the capital markets would be crucial to the continued operations o f
Flowserve. In fact, as later admitted in the restatement, Flowserve's net income was overstated i n
2001 by 600% .
9. With the 7/2/01 registration "on the shelf," Flowserve, by simply updating regularl y
filed annual, quarterly and related reports to the SEC, was able to seek the necessary equity infusion s
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when the market conditions became more favorable . The Shelf Registration provided Flowserve
with a quick market timing vehicle whereby due diligence oversight by its underwriters would be a t
a minimum at a later date when the shares were issued and this reduced scrutiny (i.e ., negligence of
the underwriters) would not reveal Flowserve's violation of its loan covenants . 2
10. Accordingly, Flowserve's 11/16/01 Prospectus Supplement pursuant to the Shel f
Registration (the "November Prospectus Settlement") became effective when - as Flowserve no w
admits in its restated financials - Flowserve was in violation of its loan covenants . Had the
Underwriter Defendants, through exercise of adequate due diligence, discovered that Flowserve was
not in compliance with its covenants, it is unlikely that the November Prospectus Supplement would
have been issued at all . In any event, the November Prospectus Supplement contained false
statements concerning the financial condition of Flowserve that were certified by PwC and the
shares issued pursuant thereto were artificially inflated . The November offering provided nearly
$163 million in proceeds for Flowserve which was used primarily to pay down its credit facilities .
Flowserve's credit facilities - the same ones that contained the restrictive covenants- were funded
by the commercial banking arm of the Underwriter Defendants .
11 . Again on 4/18/02, Flowserve sold additional shares pursuant to its Prospectu s
Supplement (the "April Prospectus Supplement"), and reaped an additional $289 .8 million in
proceeds . As with the November Offering, the April Prospectus Supplement became effective when
Flowserve was in violation of its loan covenants, was supported by false financials certified by Pw C
and was underwritten by firms which had a conflict of interest which impacted the adequacy of their
2 The "Underwriter Defendants" as referred to herein are Banc of America Securities LLC
(`BofA") and Credit Suisse First Boston LLC ("CSFB") . The Underwriter Defendants andFlowserve's auditor, PwC, together with Flowserve, Greer and Hornbaker are alleged to haveviolated § § 11 and 15 of the Securities Act of 1933 ("Securities Act") . The commission of fraud is
not required for violation of § 11 of the Securities Act .
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due diligence . The April Prospectus Supplement was issued when Flowserve stock was trading at
close to the all-time high during the Class Period and was priced at $31 .50 per share .
12. Immediately following the issuance of shares pursuant to the April Prospectus
Supplement, defendant Hornbaker engaged in substantial insider sales, exercising options and sellin g
50,000 shares - the vast majority of shares owned by defendant Hornbaker - for proceeds o f
$1,679,000 . Defendant Hornbaker' s sales were in violation of the express prohibition provided in
the April Prospectus Supplement against such sales within 90 days of the Offering . Defendant
Hornbaker has not disgorged any of her insider trading proceeds .
13. At the end of the Class Period, on 9/27/02, Flowserve warned of a 21% earnings
shortfall for the quarter ending 9/30/02 and cut its full-year 2002 earnings guidance by nearly 40% ,
to $1 .45 per share, from the $2 .30 per share earnings guidance shared with investors less than si x
months prior . Market reaction to the Company's announcement was swift and severe . Flowserve
shares fell over 38% to close at $8 .70 on 9/27/02, a decline of more than 75% from the Class Period
high of $34 .90 reached on 5/2/02. But this statement failed to disclose the whole truth . Not only
was revenue on Flowserve's income statement negatively impacted by Greer and Hornbaker's
overzealous acquisition binge, but hidden and undisclosed costs were continuing to mount .
14. On 4/27/04, Flowserve filed its restated financial statements with the SEC reportin g
the following shortfalls :
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a w
Net Earnings :20002001
2002
EPS (basic) :200020012002
EPS (diluted) :20002001
2002
A sPreviouslyReported
Inventory &Cost of Sale sAdjustments
OtherAdjustments
TotalRestatementAdjustment s(pretax)
TaxAdjustments s Restated
13 .2 (2 .2) (1 .2) (3 .4) 1 .0 10 . 8
(1 .5) (10.8) (0 .9) (11 .7) 2.7 (10.5)
53.0 (7 .6) (0 .9) (8 .5) 1 .0 45 .5
0 .35 (0 .06) 0.29(0 .04) (0 .23) (0 .27 )1 .02 (0 .14) 0.88
0 .35 (0 .06) 0 .29(0 .04) (0 .23) (0 .27 )1 .02 (0 .15) 0.87
15. Thus, the lOb-5 Defendants and PwC have publicly admitted that Flowserve' s
financial statements were false during the Class Period. Nevertheless, the lOb-5 Defendant s
continued to deceive investors about the true reasons for Flowserve's decline in revenue and
earnings and for its admittedly false accounting of costs and inventory . Instead, Greer and
Hornbaker blamed the false financials on the faulty implementation of a multi-million dolla r
manufacturing resources planning ("MRP") computer program ("BAAN")
16. In reality, the BAAN computer system did cause problems for Flowserve but it di d
not cause the financial results to be misstated . As desc ribed by CWs, routine accounting procedure s
including physical inventories conducted prior to and throughout the Class Period revealed to Greer
and Hombaker that the publicly reported inventory figures were overstated and the cost of sales was
understated . Instead of speaking truthfully about what they knew, Greer and Hornbaker, who
themselves were trained and licensed as certified public accountants ("CPA"), made a conscious
decision to make the false statements about Flowserve's financials and engage in the fraudulent act s
as described below .
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. . 1~ 1 9
17. On June 15, 2004, Flowserve announced that "Hornbaker, its vice president and chief
financial officer, has resigned for personal reasons . . . . The company has actively begun a search
process for a new chief financial officer."
18. On 10/26/04, Flowserve continued to leak out information about additional
accounting shenanigans that could result in further restatements . The 10/26/04 press release
announced the existence of material weaknesses of internal controls and that the financial results fo r
2Q04 would be amended to include "post-closing adjustments and/or recently identified out-of-
period expenses." Flowserve further announced that "[d]epending on the amount of these out-of-
period expenses, the company will assess whether a restatement is needed for certain past periods .
Based on current information, the company estimates the cumulative impact on net income to be less
than $10 million, subject to revision following further analysis ."
19. Following this announcement, at least two analysts covering Flowserve issue d
negative reports on Flowserve, stating :
• We are downgrading to Underperform [down from Marketperform], seeing this a
"last straw." We have consistently questioned FLS management credibility andexecution capabilities . [Wachovia Securities, 10/26/04 ]
• We recommend avoiding the stock . . . . the myriad of Flowserve ' s internal issues,such as the management turnstile, repeated accounting misstatements andquestionable internal controls, are too substantial to bear . . . . [Robert W. Baird & Co.,Inc. 10 /27/04]
20. On February 7, 2005, the final shoe dropped . Flowserve announced that the
additional restatement discussed to be less than $10 million on 10/26/04 (the "Second Restatement" )
was estimated to be less than $20 million "cumulative net reduction in net income," but this estimat e
was "subject to revision following further ongoing analysis ." In addition, Flowserve announced tha t
"Chairman, President and Chief Executive Officer C . Scott Greer and the company's board o f
directors have jointly agreed that Greer will not renew his contract with the company when it expire s
on June 30, 2005."
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• •
21 . The following day, on a conference call to analysts and investors , Greer admi tted that
the pump division suffered after the IDP acquisition , losing market share because of declines in "on-
time delivery and cycle times ." Flowserve 's new CFO, Mark Blinn ("Blinn"), discussed the Second
Restatement , which internally has been named "Operation Scrub ." Blinn stated that the Second
Restatement would not be finalized until 2Q or 3Q 2005, and, in addition to the material weaknesses
discussed in the 10/26/04 press release, there would be additional material internal contro l
weaknesses revealed . Therefore, after the filing of this amended complaint, Flowserve's Second
Restatement will provide further admissions relevant to the allegations of this complaint .
22. By the time of the announcements on 10/26/04 and 2/7/05, the market had already
taken into account the credibility loss of Flowserve and its management . Thus, while the volume of
trades increased dramatically following each of these announcements and the stock price declined ,
these declines were short lived and pale in comparison to the reaction by investors at the end of th e
Class Period, when confidence in Greer's and Hornbaker's veracity was lost. Indeed, investors in
this case reacted in a typical fashion when bad corporate actors are removed from their posts :
investors caused the stock to rebound after Hombaker resigned and again with the announcement o f
Greer's departure date .
B. Jurisdiction and Venue
23 . The claims asserted herein arise under and pursuant to §§10(b) and 20(a) of the
Exchange Act, 15 U .S .C. §§78j(b) and 78t(a), and Rule 10b 5 promulgated thereunder by the SEC,
17 C.F .R. §240.10b 5 .
24. This Court has jurisdiction over the subject matter of this action pursuant to 28 U .S.C .
§§1331 and 1367 and §27 of the Exchange Act, 15 U .S .C. §78aa .
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25. Venue is proper in this District pursuant to §27 of the Exchange Act and 28 U.S .C .
§ 1391(b) . Flowserve maintains its principal place of business in this District, and many of the acts
and practices complained of herein occurred in substantial part in this District .
C. The Parties
26. Lead plaintiff Alaska Electrical Pension Fund ("Alaska Fund") purchased Flowserv e
publicly traded securities during the Class Period and was damaged thereby . On 10/28/03, the Court
appointed Alaska Fund as lead plaintiff in this action . A true and correct copy of the certificatio n
filed with the Court in support of Alaska Fund's motion for appointment as lead plaintiff is attache d
hereto as Ex. B .
27. Defendant Flowserve is a New York corporation with its principal executive office s
located at 222 West Las Colinas Boulevard, Suite 1500, Irving, Texas 75039 during the relevant
time period . The Company's current headquarters are located at 5215 North O'Connor Boulevard,
Suite 2300, Irving, Texas 75039 . Flowserve's common stock traded in an efficient market on the
New York Stock Exchange ("NYSE") .
28 . Defendant Greer, at all times relevant to this action, served as the Company' s
Chairman, President and CEO and Director . By virtue of, among other things, his role as the highes t
executive officer and Director of Flowserve and the primary voice of the Company in press releases ,
filings with the SEC, conference calls and interviews, Greer is a control person of the Company a s
that term is construed by the federal securities laws. Greer is a resident of Texas and presided over
the Company from an office in Irving at all relevant times .
29 . Defendant Greer Is a Licensed CPA: Defendant Greer is a licensed CPA and has a
master's degree in accounting . Greer also had merger and acquisition experience as, prior to comin g
to Flowserve, he was the President of UT Automotive, a division of United Technologie s
Corporation, where he witnessed the strategy of rapid growth through acquisitions .
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u ti ,
30. Greer' s Incentive Compensation: As stated in Exhibit 10 .2 of the Report on Form
10-Q for the period ended 6 /30/99, defendant Greer's compensation structure gave him tremendous
incentive to inflate earnings :
Executive's Compensation. During the term of this Agreement, the Executive shall
be entitled to the following compensation :
(a) BASE SALARY . The Executive 's initial base salary shall be $600,000per year. The Executive 's base salary may be increased, but not decreasedthroughout the term of this Agreement and shall be reviewed at least once every 12months .
(b) BONUS. For each fiscal year, in accordance with the Company's annualbonus plan, the Executive shall have an annual bonus opportunity with a referencerate equal to 70% of his base salary payable pursuant to Subparagraph (a) during thatfiscal year . Upon the Executive becoming Chief Executive Officer, the referencerate referred to in the preceding sentence shall increase to 75% . The Executive shallreceive an annual bonus of at least $450,000 for fiscal year 1999 .
(e) LONG-TERM INCENTIVE COMPENSATION PLAN . The Executiveshall participate in the Company's long-term incentive compensation plan, beginningwith the three-year cycle starting in 1999 . Under the plan, long-term incentivecompensation is tied to economic value added over three-year cycles, with a newthree-year cycle beginning each year. Unless deferred pursuant to the participatingexecutive's election, payment of compensation relating to a three- year cycle is madeas soon as possible after the end of the cycle . The Executive's annual compensationunder the plan shall be paid in accordance with the plan and be equal to 50% of the
reference rate of the Executive's annual base salary payable pursuant toSubparagraph (a) .
31 . Greer's Compensation : A summary of Greer's compensation during the Clas s
Period is as follows :
Year Salary ($) Bonus ($) Other ($) Total ($)Greer 2000 617,490 551,048 2,520 1,171,058
2001 662,978 186,000 58,626 907,6042002 710,439 227,000 3,330 940,769
Total for Class Period 1 ,990,907 964,048 64,476 3,019,431
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A • ••
32. Greer' s incentive-based compensation increased his salary by over 89.2% in 2000,
28% in 2001 and 32% in 2002, giving him ample motive to perpetrate this fraud on the investin g
public .
33 . Defendant Hombaker, at all times relevant to this action, served as the Company' s
Vice President and CFO. By virtue of, among other things, her role as an officer of Flowserve and
her participation in the issuance of Company press releases, filings with the SEC and conference
calls, Hombaker is a control person of the Company as that term is construed by the federal
securities laws . Hornbaker is a resident of Texas and presided over the Company from an office in
Irving at all relevant times .
34 . Defendant Hornbaker Is an Experienced CPA: Defendant Hornbaker is also a
licensed CPA with more than 25 years of experience in accounting, auditing, financial managemen t
and business development. She was trained and employed as a CPA with a "Big Four" accountin g
firm for at least eight years, and served in senior financial positions with other companies befor e
joining Flowserve in 1996. Defendant Hornbaker was an expert in due diligence and acquisitions .
Ex. E. Between the years 1995-2000 alone, Hombaker successfully executed 16 mergers o r
acquisitions . Ann Freestone, Renee Hornbaker : Integrating Companies for Success, Strategi c
Finance, 10/1 /00, at 42 .
35 . Hornbaker ' s Insider Sales : During the Class Period, Hornbaker reported that she
owned 8,830 direct shares on 4/25/02, and 27,032 shares on 3/10/02, for a total of 35,862 shares .
Hornbaker acquired 50,000 shares through an option exercise between 4/25/02 and 4/30/02 and
turned around and sold these same shares for an enormous profit, reaping proceeds of $1,679,000 .
Her option exercise was made between $17 .812 and $22 .18 per share. This sale of 50,000 share s
represented the vast majority of shares owned by defendant Hombaker . Hornbaker's sales violated
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•
the lock-up provision provided in the 4/18/02 Prospectus Supplement, which prohibited all sales o f
Flowserve stock by insiders within 90 days of the Offering .
36. Hornbaker 's Compensation : A summaryof Hornbaker' s compensation during the
Class Period is as follows :
Year Salary ($) Bonus ($) Other ($) Total ($ )Hornbaker 2000 274,953 227,048 5,866 507,867
2001 296,308 62,000 6 ,810 365,11 82002 317,769 76,000 7,497 401,266
Total for Class Period 889 ,030 365 ,048 20,173 1 ,274,251
37. Hombaker's incentive-based compensation increased her salary by over 82 .6% in
2000, 20.9% in 2001 and 23 .9% in 2002, giving her ample motive to perpetrate this fraud on the
investing public .
38 . Greer and Hornbaker were each responsible for the false financials and each of the
press releases disclosing false financials, as they have admitted the following in Flowserve's Annua l
Reports for the years ended 2000, 2001 and 2002 :
The Company's management is responsible for preparation of the accompanying
consolidated financial statements . These statements have been prepared inconformity with generally accepted accounting principles and include amounts that
are based on management 's best estimates and business judgment . Managementmaintains a system of internal controls, which in management's opinion providesreasonable assurance that assets are safeguarded and transactions properly recorded
and executed in accordance with management 's authorization . . . .
In each of the Annual Reports, this paragraph is followed by the signatures of Greer and Hornbaker.
39. As Greer and Hornbaker were independently responsible for the false financials an d
each of the press releases disclosing false financials as they stated, under oath , in an August 14,
2002 Sarbanes-Oxley certification . See Exs . F-G. In the certification, defendants Greer and
Hombaker stated that "no covered report contained an untrue statement of a materialfact as of the
end of the period covered by such report" and that "no covered report omitted to state a material
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fact necessary to make the statement in the covered report, in light of the circumstances under whic h
they were made, not misleading ." See Exs. F-G .
40. By reason of their direct and substantial management positions and responsibilitie s
during the time relevant to this Complaint, Greer and Hornbaker were "control persons" o f
Flowserve within the meaning of §20 of the Exchange Act, 15 U.S.C. §78, had the power and
influence to control Flowserve and exercised that control to cause the Company to engage in the
violations and improper practices complained of herein . Greer and Hombaker each had access to
adverse nonpublic information about the Company's operations through the weekly Monday
morning meetings, monthly IMT and division meetings and quarterly operations meetings and as a
result of the numerous reports received by them concerning each of the line items from each divisio n
and acted to conceal and misrepresent such material information in violation of their duties and
responsibilities under the federal securities laws .
41 . Greer and Hombaker each directly participated in the management of the Company ,
were directly involved in the day-to-day operations of the Company at the highest levels and wer e
privy to confidential proprietary information concerning the Company and its operations, as allege d
herein. Greer and Hornbaker were involved in drafting, producing, reviewing and/or disseminatin g
the false and misleading statements and information alleged herein, were aware or fecklessly
disregarded that the false and misleading statements were being issued regarding the Company, an d
approved or ratified these statements in violation of the federal securities laws . Thus, the
dissemination of the false, misleading and incomplete information conveyed in the Company's pres s
releases, public statements and other publications as alleged herein is the action of Greer, Hornbaker
and Flowserve .
42 . As officers and controlling persons of a publicly held company whose common stoc k
was, and is, registered with the SEC pursuant to the Securities Act, 15 U .S .C. §78 , traded on the
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NYSE, and governed by the provisions of the federal securities laws, Greer and Hombaker each ha d
a duty to disseminate promptly accurate and truthful information with respect to the Company' s
financial condition and performance, growth, operations, financial statements, business, products,
markets, management, earnings and present and future business prospects, and to correct any
previously issued statements that had become materially misleading or untrue, so that the market
price of the Company's publicly traded securities would be based upon truthful and accurate
information. Greer and Hornbaker' s misrepresentations and omissions during the Class Perio d
violated these specific requirements and obligations .
43. Greer and Hombaker drafted, prepared and/or otherwise approved the press release s
of 2/6/01, 4/24/01, 7/24/01, 10/23/01, 2/4/02, 4/22/02, 7/22/02 and 9/27/02, all of which containe d
false and materially misleading statements . The press releases of 2/6/01, 7/24/01, 10/23/01, 2/4/02 ,
4/22/02, 7/22/02 and 9/27/02 all contained false and mate rially misleading statements that are
attributed to Greer. The press releases of 2/6/01, 4/24/01, 7/24/01, 10/23/01, 2/4/02, 4/22/02 ,
7/22/02 and 9/27/02 all included or incorporated Flowserve's financial statements which were
prepared and/or approved by Hornbaker in her capacity as vice president and CFO, and which wer e
false and materially misleading at the time they were made as evidenced by Flowserve's
Restatement . Both Greer and Hornbaker drafted, prepared and were signatories to Forms 10-K and
10-K/A filed with the SEC for the years ending 12/31/00, 12/31/01 and 12/31/02 which contained
materially false and misleading statements . Greer and Hornbaker also drafted, prepared and wer e
signatories to the 2000 Annual Report, 5/31/01 Shelf Registration, 7/2/01 Amended Shel f
Registration and supplements thereto, and the 2001 Annual Report, all of which contained materially
false and misleading statements . Both the November and April prospectus supplements incorporated
the Shelf Registration statements and Form 10-K for the year ending 12/31/00, all of which wer e
signed by defendants Greer and Hombaker. Hombaker was also the signatory to the Form 10-Q
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f 4 , •
•
filed on 11/2/01 . On 8/14/02, both Greer and Hornbaker filed statements under oath tha t
Flowserve's 2001 Annual Report on Form 10-K, all subsequent 10-Qs, 8-Ks, proxy materials an d
any amendments thereto did not contain any untrue statement of material fact or omit to state a
material fact. Each of the above-described documents contained materially false and misleadin g
statements by Greer, Hombaker and Flowserve.
44. Both Greer and Hombaker participated in the conference calls of 2/5/02 and 7/23/02 ,
during which they made materially false and misleading statements to the public . On the conferenc e
call of 2/5/02, Greer made false and misleading statements to the public, while Hombaker
participated in this call and did not correct these false statements . In the 2/5/02 conference call,
Greer presented statements prepared by, or at the direction of, Hornbaker . On the conference call of
7/23/02, both Greer and Hombaker made false and misleading statements .
45 . Greer, Hornbaker and Flowserve are each liable as a participant in a fraudulen t
scheme and course of business that operated as a fraud or deceit on purchasers of Flowserve
common stock by disseminating materially false and misleading statements and/or concealin g
material adverse facts . The scheme : (a) deceived the investing public regarding Flowserve' s
business, operations, management and the intrinsic value of Flowserve common stock ; (b) enabled
the Company to complete two public offerings of 15 .13 million shares, thereby raising more than
$452.655 million to fund the Company's acquisitions and retire debt ; (c) enabled Flowserve insiders
to sell their personally held Flowserve common stock generating millions in proceeds ; and
(d) caused plaintiffs and other members of the class to be damaged by their purchase of Flowserv e
securities at artificially inflated prices .
46 . Defendant Hornbaker ' s Due Diligence Expertise : Beyond defendant Hornbaker' s
intimate involvement with the merger, as shown below, she also publicly extolled her involvement i n
the integration process .
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•
47. In a 6/1/01 article in CFO Magazine, defendant Hombaker stated :
"Merger integration is war," says the deal-making veteran who, while inpublic accounting, worked on the 1988 leveraged buyout of Beatrice Inc . by
Kohlberg, Kravis & Roberts . "You must pursue it relentlessly, and not let the day-to-day become a distraction ." She adds that "not a day goes by when there isn'tsome discussion or analysis of our integration effort."
See Ex. I attached hereto .
48. The CFO Magazine article went on to detail Hornbaker' s hands-on due diligence o f
its acquisition targets :
Hornbaker is not one to let any detailslip by . Over the years, Flowserve has
amassed an extensive, 65 page due-diligence checklist, and relies mostly on seniordepartment heads to look under the hood . Specialists lend a hand with technicalexpertise, but Hornbaker believes that outsiders alone would miss some crucialdetails . Once, for instance, Flowserve thought a target had access to global markets,but learned that a major territory had been licensed . Another time, it uncoveredsubstantial asbestos-related liabilities .
See Ex . I attached hereto .
49. An article published in Strategic Finance on 10/1/00 again interviewed Hornbaker on
her role in Flowserve's acquisition spree :
"As CFO, it is critical to be involved in the M&A process, essentially fromthe beginning" Hornbaker says . . . .
"My role was multifaceted," continues Hombaker. "Up front and throughoutthe process, it included helping to coordinate the original transaction, especially interms of developing strategy with the CEO . Secondly, working with our investmentbankers to determine appropriate deal structure and pricing . "
She also worked with the management teams on both sides to identify,document, and quantify synergies . "The integration planning process evolved fromthat" she says . As a member of the integration steering committee , she oversaw themerger integration projects, developed tracking and reporting schedules , trackedthe milestones in the projectplans, and reported the results .
"The integration planning should start with the due diligence process . Partof the due diligence process should be to identify and confirm potential synergies . . . .""All of these issues will affect the value of the potential acquisition . "
See Ex. E attached hereto .
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• . A I
50. An October 2001 issue of Business Finance discussed Hornbaker's involvement with
mergers and acquisitions at Flowserve and repeated Hornbaker's advice to other executives :
Based on her experience with a number of M&As at Flowserve, Hornbaker advisesother finance executives "to be involved in all aspects of due diligence and in allphases of financing, negotiations and integration." She adds, `You can't just
delegate to experts."
See Ex. H attached hereto .
• Moreover, Flowserve's April Prospectus Supplement, filed with the SEC on 4/18/02stated "[o]ur management team has extensive experience in acquiring and integratingcompanies, with our company today being the product of 23 acquisitions since 1990through which more than a dozen facilities were closed or consolidated ."
D. Background Facts
51 . Flowserve was formed in 1997 as the result of a merger between BW/IP, Inc . and
Durco International, Inc . ("Durco") . The Company produces engineered and American Nationa l
Standards Institute ("ANSI") pumps , precision mechanical seals, automated and manual qua rter-tum
valves, control valves and actuators, and provides a range of related flow management services ,
primarily for the process industries .
52 . At all relevant times, Flowserve managed its operations through three busines s
segments : (a) Pump Division, which accounted for approximately 53% of the Company's sales
during 2001 ; (b) Flow Control Division , which manufactures valves and accounted for 14% of 200 1
sales; and (c) Flow Solutions Division, which manufactures mechanical seals and provides flow
management services and accounted for 33% of 2001 sales . Prior to 2002, the Company's
maintenance, repair and overhaul revenues for each of the divisions were included in the Company's
Flow Solutions Division business segment .
53. In July 1999, Flowserve hired defendant Greer as its Chairman, CEO and President.
Prior to his employment at Flowserve, defendant Greer was the president of the automotive divisio n
at United Technologies Corporation, a supplier to auto manufacturers . From this auto industry
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experience, Greer developed his mistaken belief that the integration of highly complex an d
differentiated pump and valve companies would result in dramatic synergies and cost savings .
According to Confidential Witness ("CW") 1, for Greer, the auto industry provided the justificatio n
for his acquisition scheme . Greer analogized that if you have a plant that makes spark plugs and yo u
acquire another plant that makes spark plugs, one plant can be shut down and relocated without any
negative side effects . But the massive complex pumps and valves manufactured by Flowserve and
its acquisition targets were far from spark plugs, and it was from this mentality that many o f
Flowserve's problems arose .
E. Acquisitions Completed Prior to the Class Perio d
54. During fiscal year 2000, the Company completed two major acquisitions :
(a) Innovative Valve Technologies , Inc. ("Invatec"), a valve service company, for a purchase p rice
of approximately $100 million, including debt assumptions of approximately $87 million ; and
(b) IDP, a pump manufacturer larger in size than Flowserve, for $775 million. Invatec had historical
revenues of approximately $160 million . Invatec's operations were consolidated into the Company' s
Flow Solutions Division business segment .
55 . In connection with the IDP acquisition, which closed on 8/8/00, Flowserve incurred
over $1 .1 billion in debt to fund the acquisition and integration program . The additional debt
included $750 million in term loans under a senior secured credit facility (the "credit facility") an d
$375 million from the issuance of subordinated high yield notes to the public . After the
announcement of the IDP acquisition, the Company represented in its 1999 Annual Report that cas h
flow generated from operations, including cost reduction efforts and other "synergies," would b e
sufficient to service the debt .
56. Flowserve announced the acquisition of IDP in February 2000 . This acquisition took
over seven months to close . During this period, Flowserve set up an Integration Management Team ,
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an Integration Steering Committee and other mechanisms to oversee the integration . Defendants had
ample time to prepare for the integration of these two companies .
57. Flowserve's debt structure dramatically changed with the acquisition of IDP . Tota l
debt rose above $1 .1 billion. Flowserve's interest expenses and costs to borrow money were directl y
tied to the ratio of the Company's total debt to EBITDA, 3 excluding certain non-recurring charges ,
otherwise known as the "maximum leverage ratio ." The Company's ability to maintain this ratio at
or below specific parameters , as defined under the Company's credit facility, resulted in lower
interest margins on its term and revolving loans at certain repricing intervals . Thus at all relevant
times, the lOb-5 Defendants were highly motivated to make it appear that the Company wa s
performing and would continue to perform better than it actually was .
58 . Beyond the large acquisitions of Invatec and IDP, however, Flowserve also embarked
on an acquisition spree of smaller companies, sometimes bought for pennies on the dollar .
According to confidential witnesses, because Flowserve bought these companies for almost nothing,
it decided to acquire the companies without conducting thorough due diligence . These smaller
companies were desperate to be bought and often overstated the value of their inventories to increase
their asking price. Without the completion of adequate due diligence, however, these inflated
inventory amounts found their way into Flowserve's balance sheet . Employees noticed and tried to
get these inflated inventory issues addressed by corporate management for years .
59. Around 2000, Flowserve began to implement BAAN, a computer management
system meant to standardize processes across Flowserve's various companies and divisions . As
physical invento ry counts were loaded into BAAN, they consistently disagreed with the invento ry
3 "EBITDA" generally means "Earnings Before Interest, Taxes, Depreciation andAmortization." It is commonly used as an analytical indicator and also serves as a measure of
leverage capacity and debt servicing ability .
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figures carried at the corporate level . This was, in part, because of the inflated inventory left over
from Flowserve' s acquisitions. As more acquisitions were made in the Class Period, th e
discrepancies between BAAN and the reported inventory continued to grow .
60. The combination of Greer and Hornbaker's intentional lack of due diligence ,
acquisition strategies and massive amounts of debt put Flowserve on an unsustainable course . After
years of false statements to the market, Flowserve's Restatement suggested that the nearly four-year,
$14 million or $21 .4 million pretax earnings restatement earnings Restatement was due to
"reconciliation issues at two of [the Company's] reporting locations due to difficulties associate d
with converting to new computer systems ." Of course, this is only one small piece of the real truth .
F. Witnesses/Sources of Plaintiffs' Allegation s
61 . The allegations below provide information about the 33 confidential witnesses, al l
former Flowserve employees .
62. CW1 is a former pump division operations executive, who was employed for fiv e
years, including during the first two quarters of the Class Period . CW 1 reviewed all of the quarterly
reporting of financial and sales information in the pump division. CW 1 participated in the pump
division's quarterly meetings with defendants Greer and Hornbaker, in which the details of th e
results and the forecasts for the pump division were discussed . CW 1 also participated in the ID P
acquisition and integration. CW 1 has direct knowledge of the problems associated with the
acquisition and integration of IDP into Flowserve .
63. CW2 is a former valve division sales executive, who was employed for twenty-tw o
years, including throughout most of the Class Period . CW2 reviewed the quarterly reporting of
financial and sales information in the valve division . CW2 participated in quarterly reviews, in
which each division made presentations before defendants Greer and Hombaker . These reviews
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were very detailed and were based on all information and repo rts relevant to managing the
businesses in the division . Defendants Greer and Hornbaker were active participants .
64. CW3 is a former valve division operations executive , who was employed during th e
last five months of the Class Period . CW3 has direct knowledge of the problems associated with th e
acquisition and integration of IFC into Flowserve . CW3's job duties included profit and los s
reporting responsibility for a large valve manufacturing facility, and managing the concrete problem s
arising from the incompatibility of Flowserve's products and customer base with the Company' s
strategy of centralizing management and integrating its businesses . CW3's position and experience
provided direct knowledge about Flowserve 's business strategy and reasons for IFC's integration
and centralization problems and the negative side effects of Flowserve's cost-cutting measures .
65 . CW4 is a former senior vice president in the valve division of Flowserve, who wa s
employed for seven years, including throughout the Class Period . As a part of CW4's job duties ,
CW4 managed the problems arising from the incompatibility and the negative side effects of cost
cutting, particularly concerning product sales . CW4 has direct knowledge of the problem s
associated with the acquisitions and integrations of both IDP and IFC. CW4 also provided
information regarding the incompatibility of Flowserve's products and customer base with the
strategy of centralizing management .
66 . CW5 is a former engineer and inside sales associate in the pump division o f
Flowserve, who was employed for seven years, including throughout the Class Period . CW5's job
duties required CW5 to apply specialized knowledge to match Flowserve 's products with the needs
of customers . CW5 provided information about the negative effects of Flowserve's reorganizatio n
to adopt IDP's more centralized style of management as part of Flowserve's integration of IDP .
67. CW6 is a former pump division operations executive at Flowserve, who wa s
employed for two years, including for the first half of the Class Period. CW6's job duties required
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CW6 to develop detailed knowledge of the pump division's budgeting and forecasting efforts and
the division's production problems . CW6 provided plaintiffs with factual details concerning the
systemic, underlying problems at several Flowserve pump plants, including the loss of ke y
management personnel . CW6 also has direct knowledge that defendants Greer and Hombaker knew
about these problems .
68. CW7 is a former pump division operations executive at Flowserve , who was
employed for fifteen years, through April 2002 . CW7 has direct knowledge of the problems
associated with the acquisition and integration of IDP into Flowserve. CW7 attended quarterly
meetings with defendants Greer, Hombaker, and other senior corporate management, where detailed
presentations were made regarding the prior quarter, the upcoming quarter, and the remainder of th e
year. CW7 has direct knowledge that accurate and timely repo rts were made to defendants Gree r
and Hornbaker on a weekly, monthly, quarterly and annual bases that disclosed Flowserve' s
integration dis-synergies, loss of customers and revenue shortfalls .
69. CW8 is a former vice president of finance at Flowserve, who was employed for te n
months, including during the last half of the Class Period. As part of CW8's job duties , CW8 wa s
responsible for finance and accounting functions for Flowserve's manufacturing facilities . CW8' s
job duties also included forecasting and budgets . CW8 has direct knowledge of the problems
associated with the acquisition and integration of IDP and IFC into Flowserve and the replacemen t
of IFC's sales force with outside distributors .
70. CW9 is a former pump division operations executive at Flowserve, who was
employed for two years, including most of the Class Period. CW9 participated in the pump
division's quarterly meetings with defendants Greer and Hornbaker, in which the details of th e
quarterly financials and sales results and the forecasts for the pump division were discussed . CW9
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0
has direct information regarding the difficulties experienced at Flowserve's pump facilities as a
result of the IDP integration .
71 . CW 10 is a former shipping coordinator in the pump division of Flowserve , who was
employed for two years, including during most of the Class Period . Asa part of CW 10's job duties,
CW10 was responsible for coordinating every shipment from a major Flowserve pump
manufacturing plant. Moreover, as a member of the integration team, CW 10 had direct knowledge
of the lack of training provided to transferred employees . CW 10 also has direct knowledge
regarding difficulties in the integration of IDP, as well as Flowserve's inability to fulfill orders on a
timely basis, causing the loss of significant business .
72. CW 11 is a former shipping coordinator in the pump division of Flowserve , who was
employed during the Class Period . As a part of CW 1 l's job duties, CW 11 was responsible for
handling the paperwork on shipments from a major Flowserve pump manufacturing plant . CW11
has direct knowledge regarding monthly shipping quotas, late shipments, and the shipment of poor
quality pumps, all leading to the loss of customers .
73 . CW 12 is a former pump division human resources executive at Flowserve , who was
employed for two years, including during the first seven months of the Class Period . CW 12
participated in the IDP acquisition and integration . CW 12 has direct knowledge regarding the
difficulties in the pump division following the acquisition of IDP . CW12 also has direct knowledge
regarding the quarterly review meetings attended by defendants Greer and Hornbaker and the
management teams from each division at Flowserve's headquarters .
74. CW 13 is a former valve division human resources executive at Flowserve , who was
employed for seven years, including during the entire Class Period . CW 13 has direct knowledge o f
the quarterly review meetings attended by defendants Greer and Hornbaker and the managemen t
teams from each division at Flowserve's headquarters, where quarterly financial and sales result s
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were discussed. CW13 also participated in the monthly meetings conducted by the valve divisio n
president and his senior staff.
75 . CW 14 is a former manager in the pump division of Flowserve, who was employed fo r
twenty-seven years, including throughout the Class Period . As a part of CW 14's job duties, CW14
was responsible for managing a pump plant's production, shipping and reporting processes ,
including monthly reports . CW14 has direct knowledge regarding the reports generated by
Flowserve's manufacturing facilities that were submitted to corporate headquarters on a monthl y
basis .
76. CW15 is a former regional manager in the valve division of Flowserw, who wa s
employed during the last quarter of the Class Period and for a year and a half thereafter . As a part o f
CW 15's job duties , CW 15 had the responsibility for reporting profits and losses for a group of
facilities . CW15 regularly reviewed and analyzed monthly production, cost and financial reports .
CW 15 has direct knowledge of the implementation of Flowserve's computer systems . CW 15 also
has direct knowledge of Flowserve's physical inventory procedures, the due diligence performe d
upon Flowserve's acquisition targets, and money reserves used by the Company to offset shortfall s
in revenue targets .
77. CW 16 is a former executive in the pump division of Flowse rve , who was employed
for eleven years, including throughout the Class Period. CW16's job duties required CW16 to
develop detailed knowledge of the deficiencies in the pump division's budgeting and forecasting
efforts and its fundamental production problems, which CW 16 discussed with defendants Greer and
Hombaker. CW 16 participated in the pump division's quarterly meetings with defendants Greer an d
Hornbaker, in which the details of the quarterly financial and sales results and the forecasts for th e
pump division were discussed . CW 16 participated in the IDP acquisition and integration , has direct
knowledge of the negative effects of the IDP integration, and discussed these with defendants Gree r
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and Hornbaker. CW 16 has direct knowledge of the implementation of Flowserve's computer
systems, and the disruptions caused by the integration of IDP .
78. CW17 is a former director of worldwide and project sales in the seals division o f
Flowserve, who was employed for twenty years, including during the first ten months of the Class
Period . CW17's job duties required him to manage relatively large jobs tailored to the needs of a
specific customer. In that role, CW 17 was responsible for analyzing accounts receivables . CW 1 7
has direct knowledge of the misreporting of income in the seals division, and a cash flow problem i n
the same division around the September 2001 timeframe .
79. CW 18 is a former sales manager in the valve division of Flowserve, who was
employed during the last five months of the Class Period . Asa part of CW18's job duties, CW1 8
managed the detailed weekly, monthly and quarterly mandatory sales reporting and forecasting for
his/her sales region . CW 18 has direct knowledge of the IFC acquisition and the troubles facin g
Flowserve's valve division after the IFC acquisition .
80. CW 19 is a former buyer/purchasing manager/production control supe rv isor and
materials manager in the valve division of Flowserve, who was employed for twenty-eight years,
including throughout the Class Period. Asa part of CW19's job duties, CW19 managed material
purchases and scheduled production for a large valve manufacturing facility . CW19 has direct
knowledge of the IFC acquisition and Flowserve's loss of business due to its failure to integrate IFC
into Flowserve's valve division .
81 . CW20 is a former senior accountant in the pump division of Flowse rve, who was
employed for twenty-seven years, including throughout the Class Pe riod. CW20's job dutie s
included the accounting for the cost of pumps produced at a large pump facility . CW20's
responsibilities also included costing out the pumps, making appropriate journal entries and doing
the monthly close for the cost -of-goods-sold account. CW20 has direct knowledge of Flowse rve' s
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0
pump division's cost accounting methods, its reporting lines to corporate headquarters, and
Flowserve's difficulties in implementing its computer software .
82 . CW21 is a former regional director in the industrial services group, who was
employed after the Class Period. As part of CW2l's job duties, CW21 had profit and loss reporting
responsibility for a group of facilities . CW21 regularly reviewed and analyzed monthly production,
cost and financial reports . CW21 has direct knowledge of Flowserve's Restatement, the Company's
accounting system and the Company's inventory procedures .
83. CW22 is a former senior engineer in the pump division of Flowserve, who wa s
employed after the Class Period . As a senior engineer at a large pump plant , CW22 was in charge o f
transactions with sub-contractors . In addition CW22 was responsible for the timely movement o f
pumps through the production process . CW22 has direct knowledge of the operations o f
Flowserve's pump division .
84. CW23 is a former controller in the pump division of Flowserve , who was employe d
throughout the Class Period . CW23's job duties included responsibility of all accounting functions ,
including financial reporting and consolidation of financial reports at the corporate level . CW23 has
direct knowledge of the pump division's financial reporting system, the consolidation of financia l
statements at the corporate level, and the pump division's cash flow problems .
85. CW24 is a former purchasing manager for Flowserve who was employed for at leas t
four years, including the first half of the Class Period . As a part of CW24's job duties, CW24 had
responsibilities related to procurement and accounts payable for Flowserve parts vendors for pump s
produced at the Vernon plant . CW24 was aware of new orders for pumps and lead times for
production because new orders triggered the procurement cycle for the manufacturing process .
86. CW25 is a former Flowserve manager who worked at Flowserve for three years ,
including the first months of the Class Pe riod . CW25 was responsible for engineered pumps at
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Vernon and other plants, and, therefore, had direct knowledge of problems with pumps that cause d
cost over-runs, and that the cost over-runs were hidden in work in process inventory accounts .
CW25 also had direct knowledge that such problems and cost over - runs were repo rted by each plant
in weekly, monthly, and quarterly reports .
87 . CW26 is a former Flowserve controller who worked at a European Flowserve plant
for six years, including the entire Class Period . CW26 had direct knowledge of production problems
at European plants and that such problems were covered up by adding costs to the work in proces s
account .
88. CW27 is a former Flowserve sales engineer who worked at Flowserve for two years ,
including the first months of the Class Period . CW27 was responsible for the aftermarket and
original equipment manufacturer ("OEM") sales and distribution of certain seals .
89. CW28 is a former Flowserve administrative staff member who worked at Flowserv e
for six years, including the entire Class Period . CW28 assisted in facilitating both scheduled and ad
hoc meetings of Flowserve corporate and division management ; including meetings attended by
Greer and Hornbaker. In carrying out these duties CW28 was physically close enough to meetings
attended by Greer and/or Hornbaker, particularly during quarter-end activities in the corporate
office, that CW28 was able to clearly hear Flowserve management ' s discussions o f the quarter-end
and the preparation of Flowserve's public reports .
90. CW29 is a former production planner in the pump division of Flowserve who was
employed for two years, including most of the Class Period. CW29' s responsibilities included th e
handling of production and material control for production planning, including the creation o f
schedules and work production orders to the shop floor. CW29 used the BAAN system. According
to CW29, before mid-2001 , corporate was made well aware of the implementation problems with
BAAN and the discrepancies between physical inventory counts and that reflected in BAAN .
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• •
Nevertheless, these problems were concealed until they were forced to disclose the costs hiding wor k
in process ("WIP")4 inventory through the restatement.
91 . CW30 is a former materials manager who worked in the Flowserve pump division fo r
fourteen years, including the first year of the Class Period . CW30 was responsible for performin g
physical inventory counts and locating inventory that was reflected in BAAN, Flowserve's compute r
system. CW30 had direct knowledge of the detailed assessments of inventory in the Vernon plan t
warehouse and the production floor .
92. CW31 is a former employee in the accounting department in Flowserve ' s Irving
corporate office, who worked at Flowserve for four years, including the entire Class Period . CW3 1
had direct knowledge of Flowserve's April 2004 restatement, including the reconciliations for the
general ledger that came from each of Flowserve's divisions. CW31 attended meetings for all
Flowserve controllers and their finance staff.
93 . CW32 is a former manager of manufacturing in Flowserve's pump division, who wa s
employed for five years , including the first seven months of the Class Period. CW32 has direc t
knowledge regarding the manufacturing of pumps at the Vernon plant, including the increased cos t
in making pumps experienced at Vernon . CW32 was the manager of manufacturing during the time
of the IDP integration and had direct knowledge of the influx of work to Vernon fom th e
Huntington Park, California and Phillipsburg New Jersey plants .
94. CW33 is a former vice president in the tax division and a tax accountant , who was
employed for four years, including throughout the Class Period . As a vice president of tax, CW33' s
4 Work-in-process inventory are goods at any stage of the manufacturing process short ofcompletion . The work-in-process inventory account is used (1) to accumulate the manufacturingcosts relating to all units of product worked on during the period; and (2) to allocate these costsbetween those units completed during the period and those that are only partially completed at periodend.
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17-A •
responsibilities were to make sure that appropriate tax returns were filed, that IRS questions or audit s
were defended and that acquisitions were completed in a tax efficient way. CW33 saw Flowserve's
budgets and forecasts as a result of his/her activities during the company's quarterly reporting
exercise . CW33 had direct information regarding the difficulties experienced at Flowserve's pump
facilities as a result of the IDP integration, witnessed the build-up of inventory and attempted to
quantify the write-off necessary for such inventory . Hombaker rejected CW33's attempts to
quantify slow- moving and obsolete ("SLOB") inventory and rejected writing off SLOB inventory .
G. Greer and Hornbaker Were Each Actively Engaged in the AcquisitionProcess
95. Defendants Greer and Hombaker were not only actively involved in the integratio n
and acquisition process, but also, as acknowledged in public documents, retained ultimat e
responsibility for all decisions made during the process .
96. During the IDP merger, defendants Greer and Hombaker were members of the
Integration Steering Committee, which was tasked with overseeing all aspects of the integration .
The contract between Flowserve and the IMT, signed by defendant Greer on August 23, 2000 mad e
clear that the Integration Steering Committee would have full oversight of all integration activities :
• The IMT was required to "meet regularly with the Integration Steering Committeeto resolve questions , report on progress and reestablish support and authority"
• The Integration Steering Committee met, "at a minimum , every two weeks to reviewthe progress ofeach Integration Team and to address any requested decisions ." Theteam plans could "not be changed by anyone in the organization without the approvalof the Integration Steering Committee "
• "A full written and oral report of all synergy actions and associated metrics will bemade to the Integration Steering Committee bi-monthly or as requested by the CEOor President of the Pump Division"
• "[No changes may be made to the approved integration plans without the approvalof the Integration Steering Committee"
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97. The IMT contract made clear that ultimate responsibility for all decisions lay with
defendant Greer:
• "The Integration Management Team ("Team") exists separately from the Flowserveorganization to ensure that the detailed integration plans developed by theintegration teams and approved by Scott Greer . . . are executed as planned"
• The Integration Steering Committee would "discuss each requested decision andrecommended course of action but the CEO will make the final decision "
• If the Team, or any one of its members, believe that the achievement of theintegration goals of the Company are in jeopardy, it or its members are directed totake all necessary steps to bring the danger to the attention of the CEO, presidentof the pump division or any other office of the Compan y
98. The IMT contract also evidenced that defendant Hombaker was kept abreast of al l
integration developments through weekly reports, beyond the full written reports given brmonthlyto
the Integration Steering Committee :
To ensure goal attainment synergies will be tracked by an independent sub-team andreported weekly to the CFO of the Company and audited at her discretio n
A `full written report of all synergy actions and associated metrics will be made tothe CFO weekly by the Integration Management Team in the form requested by theCFO"
99. The employment contract with the head of the IMT, signed by defendant Greer on
1/9/01, required that the staff integration leader of the IMT :
Tracking and Reporting . Provide timely and accurate weekly and monthly trackingand reporting of Integration Plan action plan execution actions and resulting metricsto the Chief Financial Officer of the Company and to the Integration SteeringCommittee .
Synergy Plan Forecasting . Provide monthly, to the Integration SteeringCommittee, accurate and timely forecasts regarding the future action execution andresulting metric results from such plan execution .
Strict Adherence to the Integration Team Chartered Procedures andGuidelines : Be the primary leader in ensuring that the rules, guidelines and
processes established by the Integration Steering Committee are followed religiously,to include, obtaining Integration Steering Committee approval for ALL Integration
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Plan changes and ensuring that the Company's functional departments do not delayplan execution.
H. Greer, Hornbaker and Flowserve's Knowledge Was Gained, in Part,Through Attendance at Meetings
100. Greer and Hombaker attended meetings and received reports that depicted
Flowserve's problems with the integration of the IDP and IFC acquisitions, inferior quality o f
products and timeliness of deliveries to customers and problems maintaining compliance with its
loan covenants. Greer and Hornbaker participated in weekly, quarterly and annual meetings with the
head of each division, where each of these problems was extensively discussed . Thereby, Greer and
Hornbaker obtained actual knowledge of Flowserve's increasing difficulties in meeting its loan
covenants, the necessity of the stock offerings and the difficulties in integrating its acquired
companies , particularly IDP and IFC .
1 . Weekly Presidents ' Meeting s
101 . CW2 informed plaintiffs that weekly meetings took place between defendant Greer
and his senior management team , including defendant Hombaker, Vice President, Secretary and
General Counsel Ronald R . Shuff ("Shuff '), and Vice President and Corporate Controller Kathleen
Giddings ("Giddings"), as well as a representative from each of the pump, seal, valve, repair and
service divisions . These meetings, called "Presidents' Meetings," took place on Mondays, typically
in the morning, at the headquarters' building in Irving, Texas .
102 . As discussed below, through these meetings, Greer and Hombaker had actual
knowledge of the ongoing difficulties in the pump division .
2. Quarterly Meetings
103 . CW2, CW7, CW 12 and CW13 independently informed plaintiffs that qua rterly
meetings took place between Greer and his senior staff, including defendant Hornbaker, Shuff an d
Giddings, as well as senior management for each division . These meetings took place over a one-
week period, which included two to three days for preparation of the presentation, one day to make
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the presentation to defendants Greer and Hornbaker and one day for debriefing . CW25 stated that
quarterly meetings were usually held two to three weeks after the end of the quarter, i .e ., mid-April ,
mid-July, mid-October, and mid-January .
104. According to CW26, each of these quarterly meetings lasted for a full day for the
pump division and they were an exhaustive examination of the problems faced by each plant tha t
was not making its target numbers. Defendant Greer ran these meetings , assisted by defendant
Hornbaker, and they placed emphasis on the negatives : the details of each particular failure, the
reasons for the failure, and the plans for fixing the failure . According to CW26, both Greer and
Hornbaker were very familiar with the details in the monthly and quarterly reports from each plan t
and they made frequent use of those reports in the quarterly meetings .
105. According to CW2, at quarterly meetings , each division made presentations to
defendants Greer and Hornbaker which were very detailed and based on large notebooks filled wit h
information and reports relevant to managing the businesses in each division . Defendants Greer and
Hombaker were active participants in each of the quarterly meetings throughout the Class Period .
106. CW33 attended "quarterly review" meetings, which involved "presentations by th e
troops" - the vice presidents of different divisions and finance- to the executives . CW33 stated that
by the time of these meetings, budgets were set and the presentations CW33 witnessed were
basically final exercises before the budget was released .
107. As discussed in ¶¶62, 70, 73-74, 88, 121-122, 125, 215, 218 and 222-223, throug h
these meetings, Greer and Hornbaker received constant updates on the status of Flowserve' s
operations .
3. Annual Controllers' Meeting
108 . An annual controllers' meeting took place each year and was attended b y Hombaker .
According to CW26, these meeting took place 9/00 in Dallas, summer 2001 in Europe ; May-Jun e
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2002 in Brussels , and in Paris in 3/03 . At these meetings , CW26 discussed with defendant
Hombaker the inability of the Etten-Leur pump plant to meet its target numbers .
109. As discussed in ¶1217 and 337- 338, according to CW26, Hornbaker had actual
knowledge of the inability of Etten-Leur to meet its numbers .
4. Weekly, Monthly and Quarterly Report s
110. According to CW7, each division submitted weekly reports that included a narrative
description of concerns and problems. Defendants Greer and Hombaker received these weekl y
reports .
111 . CW14 informed plaintiffs that each manufacturing facility generated a monthly
report, which was sent to both the regional and corporate headquarters . Monthly reports from th e
individual facilities were rolled up again at the regional level and submitted to corporat e
headquarters each month .
112. According to CW26, the monthly reports and quarterly reports presented the budge t
targets (i. e., the "Plan"), the forecast and the actual results for the period at hand . A major feature of
these reports was the comparisons among the Plan, the forecast and the actual . The reports' major
focus emphasized the deviations from the Plan by the forecast and the actual results, and the
differences between forecast and actual amounts .
113 . According to CW7, the quarterly report was also called the "Presidents ' Report . "
CW26 informed plaintiffs that both Greer and Hornbaker were very familiar with the details in th e
monthly and quarterly reports from each plant and they made frequent use of those reports in th e
quarterly meetings .
114. As discussed in ¶¶97-98, 210, 217, 236, 267, 295-296 and 338, through these reports ,
Greer and Hornbaker had actual knowledge of all difficulties experienced by the divisions during th e
Class Period .
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5. Budget Presentation Meeting s
115. CW2 informed plaintiffs that pe riodic budget presentation meetings took plac e
between Greer and his senior staff, including defendant Hornbaker, Shuff and Giddings , as well a s
senior management for each division .
116. As discussed in ¶¶209, 234, 235 and 237, Greer and Hombaker had actual knowledge
of the divisions' inability to meet their mandated budget "plan ."
6. Monthly Integration Management Team Meetings
117. CW7 informed plaintiffs that, as part of the IDP acquisition, Flowserve formed the
IMT to assist in the integration of IDP. The IMT was made up of high- level managers and
consultants , who met monthly with Greer and Hornbaker and other senior managers to discuss issues
surrounding the integration of IDP .
118. As discussed in ¶¶110-114, at each of the above-referenced meetings, Greer and
Hombaker had reports that provided actual and forecasted results for each division and reflected th e
actual and forecasted synergies and dis-synergies of the acquisition integrations .
119. As discussed in ¶¶96-99, 214, 220, 239, 259 and 302, through these meetings ,
defendants Greer and Hornbaker were kept informed and, indeed, were in complete control of th e
IDP integration .
1. Greer and Hornbaker Insisted upon Preordained Result s
120. Throughout the Class Period, defendants Greer and Hombaker either had knowledge
of the fraud ongoing at Flowserve operations, or were deliberately reckless in not discovering thi s
fraud . As demonstrated through the meetings periodically attended by defendants Greer an d
Hombaker and the regular reports received by Greer and Hornbaker, they were intimately familiar
with all aspects of Flowserve' s business . If they were unfamiliar with any of the distinct instances o r
methods by which the false results were derived, it was because Greer created an environment where
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executives had no choice but to commit fraud to achieve his preordained results, as described below .
Thus, any ignorance on the part of Greer and Hornbaker was because of their deliberate blindness .
121 . According to CW25, the cost over-run problems experienced by Flowserve due to th e
integration difficulties were repeatedly repo rted to Greer and Hombaker . CW25 also said that Greer
enforced a corporate culture of not reporting negative information, such as failure to mak e
target/forecast numbers . Executives who reported such failures (i .e ., the true financial results) were
publicly berated in quarterly meetings and sometimes fired . To avoid such chastisement, executives
covered up cost over-runs by hiding them in WIP . CW25 said that Greer and Hornbaker had
knowledge about such cover-ups because they knew about the underlying facts that caused the cost
over-runs . CW25 explained that once one knows, as Greer and Hornbaker knew , the facts (e.g. ,
product failure at the "test stand," inability to make timely shipments because products had to b e
reworked extensively, and IDP integration dis- synergies), the conclusion becomes obvious even i f
unspoken . CW25 explained further that there are only three methods for handling a cost over-run :
(1) ask customer to pay more - unlikely to happen; (2) account for the over-run by showing a
reduction in profit or increase in loss - not an option with Greer; or (3) bury the over-run in WIP .
CW25 said that Greer and Hornbaker knew that the since the other two options were not used, th e
over-runs were buried in WIP .
122. According to CW 12, there was no doubt that defendants Greer and Hornbaker knew
about the cost over- runs because Greer and Ibrnbaker "always pushed back" when informed o f
negative results . When confronted with cost over-runs and or untimely shipments that undermine d
the quarterly numbers, Greer and Hornbaker would demand of the executive making the presentatio n
"what are you putting in its [the failed job's] place to make the forecast numbers ." CW12 said thi s
was evidence that Greer and Hornbaker would not accept a change in the forecast even if the results
dictated it. In quarterly meetings, CW12 and CW33 witnessed Greer' s abusive and intimidating
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behavior toward pump division executives. CW 12 said that Greer "put the pressure on people" t o
accept his view and "fmd a way to make the numbers work ," even if those numbers did not reflect
reality . And CW12 said that Greer did this both "on and off the record."
123. According to CW2, Greer " intimidated people away from bringing bad news . "
Defendant Greer would sometimes "snap" in meetings and use offensive language, making example s
out of people who brought bad news, such as a low forecast . According to CW2, defendant Greer
"hindered the flow of honest feedback," as employees knew that if they did not do what defendant
Greer wanted, they would be fired and a replacement would be brought in . Defendant Greer's
custom was to "fire the bearer of bad tidings ." CW27 and CW33 confirmed that defendant Gree r
fired people who disagreed with him.
124. CW27 stated that Greer managed by intimidation so that no one would "rock th e
boat ." In other words, CW27, "you had to keep your mouth shut ." According to CW7, in the 10/0 1
quarterly meeting, defendant Greer stated that "If management can't do it [make and ship pumps o n
time], fire them and get people who can." Defendant Greer stated at this meeting that he did not
want to hear about integration problems, he just wanted his preordained results .
125. All of this information was confirmed by CW28, who stated that during the Quarterl y
Meetings , Greer often got "hot" and yelled things to the effect of "You've got to get me somethin g
better than that!" CW28 specifically recalled that these outbursts related to the financial result s
being presented to Greer . CW28 witnessed Greer's temper, including his firing of severa l
employees .
126. According to CW3 1, Greer was very hard on the finance department and divisio n
management and had a reputation for first berating and then firing those who failed to report the
numbers Greer sought . CW31 described Greer's unprofessional and abusive conduct toward such
individuals, giving examples of profane language (i.e., "You are dogsh* * ! Your numbers are crap !
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0 9
Go fix this ! "), which was screamed or yelled audibly outside the boardroom where Geer conducte d
some of these meetings . CW31 overheard such abuse at least ten times, and the subject ma tter was
always financial in nature .
127. According to CW33, Greer was a "pushy guy who always lacked follow through . "
CW33 noticed that during budgeting exercises at the "quarterly review meetings ," Greer typically
and arbitrarily assigned financial targets to responsible managers regardless of what actuals showed
or what these managers believed was possible .
128 . According to CW33's direct observations, Hornbaker followed Greer's orders and
"spent a lot of time" preparing financial information the way he wanted it done . CW33 added that
"in the worst way," Giddings then followed Hornbaker's directives, which many times involved
making changes to various accounting reports . CW33 said that Hornbaker would, at times, get
information prepared to "say something to Scott" (something adverse to Greer's position) .
According to CW33, Giddings was like Hornbaker's "slave" and assembled scenarios exactly as
instructed to support Hombaker's challenges to Greer over finance issues . Ultimately, however ,
CW33 said that Hornbaker's periodic oppositions to Greer were futile, as she ultimately did wha t
Greer demanded .
J. Flowserve' s False Financial Statements
129 . In order to inflate the price of Flowserve securities and, among other things , maintain
its credit rating, maintain access to the capital markets and avoid default of certain debt covenants ,
Greer and Hornbaker caused the Company to falsely report its financial results in violation of
Generally Accepted Accounting Principles ("GAAP") and SEC rules for: (i) fiscal years 2000, 200 1
and 2002 filed with its Forms 10-K and Registration Statements ; (ii) the 2000, 2001 and 200 2
quarters filed on Forms 10-Q ; (iii) the first three quarters of 2003 filed on Forms 10-Q ; and
(iv) financial results included in press releases and other SEC filings throughout the Class Period .
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They did so primarily by improperly understating current cost of sales expenses, improperl y
overstating inventory, managing earnings using "cookie jar" reserves, and disguising operatin g
expenses as one -time charges .
130. As noted above, these accounting improprieties violated GAAP and SEC rules .
GAAP are those principles recognized by the accounting profession as the conventions, rules and
procedures necessary to define accepted accounting practice at a particular time . SEC Regulation
S-X (17 C.F.R. §210.4-01(a)(1)) states that financial statements filed with the SEC which are no t
prepared in compliance with GAAP are presumed to be misleading and inaccurate, despite footnote
or other disclosure . Regulation S-X requires that interim financial statements must also complywit h
GAAP. 17 C .F . R. §210 . 10-01(a) .
1. Flowserve Restates Almost Four Years of Financial Statement s
131 . There is no dispute about the falsity of Flowserve's financial statements . As a result
of employing the improper accounting practices as alleged herein throughout the Class Pe riod,
Flowserve was ultimately forced to restate its previously released financial statements for all of
2000, 2001 , 2002 and the first three qua rters of 2003 to comply with GAAP . This Restatement was
material and decreased net income by 18 .3%, 600 .6%, and 14 .2% in the years 2000, 2001 , and 2002,
respectively .
Net Income (in $000's )Reported Restated
FY00 13,241 10,822FY01 (1,497) (10,488)FY02 53,025 45,497Total 64,769 45,831
Difference18.3%
600.6%14.2%29.2%
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132. Similarly, the Restatement materially decreased Flowserve's net income in eachs o f
the quarters from 4Q00 through 4Q02 as illustrated in the table below :
Net Income (in $000's)Reported Restated Difference
4Q00 1,700 (700) 141 .2%1Q01 (8,540) (10,300) -20.6%2Q01 2,602 (100) 103 .8%3Q01 5,833 2,900 50.3%4Q01 (1,392) (3,000) -115.5%1Q02 12,737 8,987 29.4%2Q02 14,345 14,900 -3 .9%3Q02 9,347 8,100 13 .3%4Q02 16,596 13,500 18.7%
133 . For the reasons stated below, the fact that Flowserve restated its previous financia l
statements is an admission that : (i) the financial results originally issued during the Class Period and
its public statements regarding those results were materially false and misleading and (ii) the
financial statements reported during the Chss Period were incorrect based on information available
to the 10b-5 Defendants at the time the results were originally reported .
134. As recently noted by the SEC, "GAAP only allows a restatement of prior financial
statements based upon information `that existed at the time the financial statements were prepared," '
and "restatements should not be used to make any adjustments to take into account subsequen t
information that did not and could not have existed at the time the original financial statements wer e
prepared."6 The Accounting Principles Board ("APB"), the governing body that promulgated the
Net income increased slightly (3 .9%) in one quarter, 2Q02 . This is not surprising as this was
toward the end of the class period. Such an increase is consistent with plaintiffs' allegations as itillustrates that Flowserve was forced to remove expenses from later quarters in which they were
improperly recognized and instead properly recognize them in earlier quarters .
In re Sunbeam Sec. Litig ., No . 98-8258 - Civ .-Middlebrooks (S.D. Fla .), SECAmicus CuriaeBrief Regarding Defendants ' Motion In Limine to Exclude Evidence of the Restatement and theRestatement Report (fi led Jan. 31 , 2002) .
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accounting rules regarding restatements of prior financial statements , has defined the only kind of
"errors" that may be corrected through a restatement: "Errors in financial statements result from
mathematical mistakes, mistakes in the application of accounting principles, or oversight or misuse
of facts that existed at the time that the financial statements were prepared." See APB ¶¶20, 7-13 .
Indeed, as alleged herein, the Restatement at issue here was not due to a simple mathematical error,
honest misapplication of a standard or oversight, rather, as alleged below, it was due to intentiona l
misuse of the facts that were known at the time the previous financial statements were disseminate d
to the public .
135 . The SEC has recently reiterated its position that, in its investigations of restated
financial statements, it often finds that the persons responsible for the improper accounting acte d
with scienter :
[T]he Commission often seeks to enter into evidence restated financial statements,and the documentation behind those restatements, in its securities fraud enforcementactions in order, inter alia, to prove the falsity and materiality of the originalfinancialstatements[and] to demonstrate that persons responsible for the originalmisstatements acted with scienter . . . .
Sunbeam, No. 98-8258 Civ .-Middlebrooks, SEC Amicus Curiae B rief.
136 . The restatements at issue in this case contain at least the following indicators o f
scienter :
137 . The type of restatement (misuse of the facts) - The Restatement at issue was not
due to simple mathematical error or honest misapplication of an accounting standard or oversight . I t
was due to misuse of the facts . As alleged herein, Flowserve knew inventory obtained throug h
acquisitions was materially inflated and knew through taking physical inventory counts and other
measures that its actual inventory was materially lower than that recorded in the Company's books .
Despite this knowledge, Flowserve refused to make the required adjustments to correct the financia l
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statements because it would increase expenses and negatively affect the Company's financial
position and thus jeopardize its ability to secure further debt and equity financing at acceptable costs .
138 . The size of the restatement - The restated net income figures indicate that ne t
income, as originally reported, was inflated by 18.3%, 600.6% and 14 .2% in 2000, 2001 and 2002 ,
respectively .
139. The duration over which the improper accounting was perpetrated- As more
fully detailed herein , this is not a case of an honest mistake or oversight during a single quarter or
even a single year that was realized and corrected on a good faith basis . Flowserve restated nearly
four years offinancial statements to correct fraudulent accounting in 2000 through the third quarter
of 2003, and only after the accounting shenanigans could no longer be concealed .
140. The fact that Flowserve would not have been in compliance with at least two o f
its financial covenants had it not been for its improper accounting - Had Flowserve reported the
true financial information, its default on at least two of its financial covenants agreed to in its credit
agreement with its lenders for at least the periods 3Q01, 4Q01 and 1Q02 would have been
discovered and would have precluded or severely restricted its ability to refinance and increase its
bank loans .
141 . The types of accounting gimmicks employed - As detailed herein, the improper
accounting corrected by this restatement did not occur as a result of good faith differences in
accounting judgments, or interpretations of complicated or vague accounting rules . The accounting
gimmicks used by Flowserve are as old and basic as they come - namely, the improper delaying of
expenses to later periods in order to inflate the current period's financial position . In this case,
Flowserve violated the basic, fundamental rule of expensing the full cost of manufacturing a product
in the same period the inventory is sold .
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142. The fact that the improper accounting was widespread, pervasive, systematic
and not limited to a single division or subsidiary - The Restatement affected two of Flowserve' s
divisions, the pump and valve divisions . Together these divisions accounted for 67% of tota l
revenue reported in 2001 .
143 . The fact that the aggregate purported "errors" in 11 of 13 restated quarters jus t
happened to inflate, not reduce, net income and EPS .
144 . The improper accounting was not a result of inexperienced accounting managers
who did not understand accounting rules, nor can it be blamed solely on implementation of a
new accounting system and poor accounting controls - To the contrary, Flowserve's CFO, many
of its controllers at the various divisions, and its CEO and CFO were experienced CPAs and
seasoned financial professionals with significant cost accounting, auditing and SEC reporting
experience . Defendant Hornbaker, the CFO, for example, is a licensed CPA with more than 25 years
of experience in accounting, auditing, financial management and business development . She trained
and was employed as a CPA with a "Big Four" accounting firm for at least eight years and
subsequently served in senior financial positions with several other major companies prior to joining
Flowserve in 1996 . As a result of her "Big Four" accounting and auditing background, she was well
versed in evaluating, establishing, and auditing inventory, manufacturing costs and internal
accounting controls . Similarly, Defendant Greer, the CEO, is also a licensed CPA and even has a
master's degree in accounting . As such, Greer and Hornbaker were thoroughly versed in cost
accounting procedures, financial reporting and internal accounting control, and, as alleged herein,
knew of the accounting discrepancies .
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2. Flowserve Overstated Inventory and Understated Cost of Sale s
145. Flowserve overstated its inventory and understated its cose of sales expense, resultin g
in inflated operating income, EBITDA and net earnings in its year-end 2000, 2001 and 2002
financial statements , as well as the quarterly financial statements filed with Form 10-Q for those
years . Flowserve accomplished this in at least three ways. First, Flowserve failed to record a s
expense, the full cost of manufacturing a product in the period the product was sold as required b y
GAAP. By improperly recording only a po rt ion of the true cost of manufactu ring its products as
expense and leaving the remaining portion of costs buried in the WIP component of the inventor y
balance on Flowserve's books, Flowserve understated the cost of sales recorded on the Company' s
Income Statement, and inflated the inventory figure on the Balance Sheet . GAAP requires that the
full cost of manufacturing a product be matched against the revenue from selling that product, in th e
same period . ARB No. 43, Chapter 4, ¶4 states :
In accounting for the goods in the inventory at any point of time, the major objectiveis the matching of appropriate costs against revenues in order that there may be aproper determination of the realized income . Thus, the inventory at any givendate isthe balance of costs applicable to goods on hand remaining after the matching ofabsorbed costs with concurrent revenues .
146. Similarly, Financial Accounting Standards Board ("FASB") Statement of Concept s
("FASB CON") No. 6, ¶ 145 emphasizes the need and impo rtance of the matching principle o f
accounting :
Thus, recognition of revenues, expenses, gains, and losses and the related incrementsor decrements in assets and liabilities - including matching of costs and revenues,allocation, and amortization - is the essence of using accrual accounting to measureperformance of entities .
7 As applied to inventories, cost is the sum of the applicable expenditures and charges directlyor indirectly incurred in bringing an item to its existing condition and location, as defined byAccounting Research Bulletin ("ARB") No . 43, Chapter 4, Statement 3 .
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147. Flowserve also violated GAAP and its own publicly stated policy of accounting fo r
inventory by improperly failing to write down the value of its inflated inventory to the lower of cos t
or market in its 2000, 2001 and 2002 financial statements . Flowserve explicitly stated in its financial
statements filed with the SEC for the years 2000, 2001 and 2002, that its policy was to stat e
inventories at the lower of cost or market. As discussed below, Flowserve knew that its recorde d
inventory balances were inflated throughout the Class Period. ARB No. 43, Chapter 4, Statement 5
requires inventory impairment to be written down as a charge against income in the period in whic h
it occurs . Specifically, ARB 43, Chapter 4, Statement 5 states :
Where there is evidence that the utility of goods, in their disposal in the ordinarycourse of business, will be less than cost, whether due to physical deterioration,obsolescence, changes in price levels, or other causes, the difference should berecognized as a loss of the current period . This is generally accomplished by statingsuch goods at a lower level commonly designated as market . . . . Thus, in accountingfor inventories, a loss should be recognized whenever the utility of goods is
impaired . . . .
148 . Flowserve's management knew that the full cost of manufacturing its products wa s
not being properly recognized as an expense in the same period the products were sold, and the y
knew that inventory balances were overstated for several reasons . For example, basic accounting
procedures and controls are well established by the accounting profession to ensure tha t
manufacturing costs are properly matched with revenues in the appropriate period, and that th e
remaining inventory is accurate. For example, two of the universal procedures to ensure tha t
inventory and cost of sales figures are accurate are to conduct wall-to-wall physical inventorie s
and/or periodically analyze variances between "standard costs" and "actual costs ." Flowserve
applied these procedures widely .
149 . CW15, CW20, CW21 and CW29 have independently confirmed that wall-to-wal l
physical inventories were conducted at the various Flowserve plants and offices at least once a year ,
typically in the September or October timeframe . During a physical inventory, the inventory at a
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particular location is counted by Flowserve's employees, including raw materials and WIP, as well
as finished goods. The results of the physical inventory are then compared to the inventory balance
on the Company's books . If there is a discrepancy between the physical inventory results and what
the Company's books reflect (e.g., if the books show a greater amount than the physical inventory
results), an expense adjustment is made to reduce the inventory on the books to actual, with a
corresponding adjustment made to increase cost of sales . For example, each year with the assistance
of PwC, a wall- to-wall full physical invento ry was performed at the Vernon, Califo rn ia location-
one of the facilities with significant invento ry problems. Flowserve utilized this process for the
express purpose of determining whether its invento ry and cost-of-sales figures at Vernon were
accurate . Accordingly, Flowserve knew what its actual inventory balance was at Vernon, and that it
did not agree with the amount recorded on the Company's books . In another example, at least two
CWs, CW 15 and CW2 1, indicated that by the fall of 2002, the physical inventory count conducted at
one of their divisions alone reflected an overstatement of about $7 million, much of it representing
inflated, nonexistent or unusable inventory obtained as part of previous acquisitions . This was
brought to corporate management's attention in 2002 and 2003, but the problem was never
remedied. The same known $7 million overstatement remained on Flowserve's books for more than
a year and was once again addressed both at the local and corporate levels at the conclusion of the
physical inventory count the following year, in the fall of 2003 . CW21 also stated that the physical
inventory counts were loaded into the BAAN system and these amounts consistently differed from
the inventory figures on corporate's books. CW21 related that from the time of the Invensys
acquisition in 2000 through 2003, middle management tried to get corporate level management to
address this discrepancy between the BAAN system and the corporate accounting records, but year
after year, management refused to make the necessary adjustments to corporate's books to correctly
reflect the true number .
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1]
150. A second way Flowserve overstated its inventory and understated its cost of sales
expense was by failing to wri te off artificially inflated or obsolete or unusable inventory obtained
through its acquisitions of other companies . For example, CW 15 and CW21 stated that it was wel l
known within Flowserve that many of the acquisitions were of small companies that were seeking to
be bought, and in an effort to make themselves more attractive (i.e ., more liquid) to the likes of a
suitor like Flowserve, they typically inflated inventories, and even went as far as including non-
inventory assets, such as equipment and office furniture in inventory figures . Accordingly, CW21,
insists it was "predictable" that inventory balances would be inflated by hungry owners wanting to
sell, and therefore, predictable to the 1Ob-5 Defendants that the inventory balances could not b e
relied upon. Despite the knowledge within Flowserve that the acquirees' inventories were likely
inflated, Fbwserve performed very limited due diligence, if any, with regard to many of the
acquisitions prior to 2003 and did not count, evaluate or correct the inventory balances in a timely
manner after the close of an acquisition . Instead, according to CW 15 and CW2 1, when a company
was acquired, corporate management would merely set up a speci fic sub - ledger within the general
ledger for the gross inventory amount as represented by the acquired company . If there was any
doubt that the invento ry balances from acquired companies were inflated, those doubts were clearl y
erased when the annual physical inventory counts were performed and the discrepancies laid bare .
Yet, Flowserve still failed to make the approp riate , necessary adjustments to correct discrepancies in
the previously acquired companies' inventory balances necessary to ensure that its 2000, 2001 and
2002 financial statement balances were accurate .
151 . Flowserve also learned it was understating costs when it performed additional
procedures during 2000, 2001, and 2002 to determine whether it was recording the true costs o f
producing its products . For example, according to CW20 , when a customer job ended and the pa rt
was shipped to the customer, or at least once a month during the monthly close, Flowserve woul d
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I I-A 0
figure out the actual cost of each part that shipped and an analysis was performed in which the actua l
cost to produce the part was compared to the standard cost recorded on the books . Any varianc e
between actual and standard costs would have been identified, and if the actual cost was more tha n
the standard cost recorded on the books for that part, a journal entry was supposed to be made to
increase cost of sales to the correct amount . Because this journal entry was not made, the cost s
remained in WIP inventory .
152 . Accordingly, for the reasons discussed above, Greer, Hornbaker and, therefore ,
Flowserve knew throughout the Class Period that inventory was inflated and cost-of-sales wer e
artificially understated , but refused to make the necessary adjustments required by GAAP to correc t
the 2000, 2001 and 2002 year-end and quarterly financial statements because they did not want t o
recognize the actual expenses .
3. Earnings Management" Through the Improper Employmentof "Cookie Jar" Reserves
153 . By 2002, if not earlier, Flowserve management regularly employed "cookie jar"
accounting - the practice of maintaining reserves that can be used to improperly pad revenues during
lean times . Flowserve "managed earnings" by maintaining various types of cookie jar reserve s
including accruals, allowances and liability accounts from which it would improperly offset
shortfalls in quarterly revenue targets or unfavorably high quarterly expenses . These reserves were
commonly used at Flowserve and were referred to internally as "slush funds" or "rainy day funds ."
For example, CW 15 related that each group within the Company had such a slush fund and when a
division was experiencing a shortfall in earnings, it was not unusual for an employee to learn throug h
conversations with corporate management that the reserve was being used to offset the divisio n
shortfall . CW 15 was also certain that such transfers from reserve accounts could not have been done
without the approval of the vice president and controller of the valve division and employees in
corporate finance . CW15 believed that reserve transfers, each ranging up to $200,000 in his/he r
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division alone, were used to artificially increase revenue or reduce expense in a particular quarter on
several occasions . CW 15 also heard financial managers in the pump division mentioning that the
pump division was using the "slush fund" reserves to "make up for bad months" during the Clas s
Period as well.
154. GAAP prohibits the use of reserve accounts for general or unspecified purposes .
FASB Statement of Financial Accounting Standards ("SFAS") No . 5, Accounting for Contingencies ,
¶14. The SEC prohibits the management of earnings, including the employment of unsubstantiate d
or bogus reserves to manage earnings and has disciplined registrants for employing this practice .
SEC Accounting and Auditing Enforcement Release ("AAER") No . 1563 . By improperly using
"slush funds" and "rainy day funds" to manage earnings, Flowserve materially8 inflated its earning s
in its 2002 publicly released quarterly financial statements, if not earlier .
4. Flowserve 's Disclosures about Its Debt Covenant ComplianceWere False
155. Flowserve explicitly stated in the footnotes to its 2001 financial statements that it wa s
in compliance with all covenants under its debt facilities . This statement was false however, as
Flowserve has admitted in its restated 2002 Form 10-K on Form 10-K/A filed 4/27/04 . Once the
financial statements were restated to correct the improper accounting, the truth was revealed that the
Company did not comply withat least two of the financial covenants under its senior credit facilitie s
° SEC Staff Accounting Bulletin ("SAB") No . 99, 1 . - Assessing Materiality specifies thatsuch "earnings management" is presumably material : "While the intent of management does notrender a misstatement material, it may provide significant evidence of materiality . The evidencemay be particularly compelling where management has intentionally misstated items in thefinancial statements to `manage ' reported earnings. In that instance, it presumably has done sobelieving that the resulting amounts and trends would be significant to users of the registrant'sfinancial statements. The staff believes that investors generally would regard as significant amanagement practice to over- or under-state earnings up to an amount just short of a percentage
threshold in order to ` manage ' earnings ."
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. , I I A . 00
for three consecutive quarters (3Q01, 4Q01, and 1Q02), namely the "maximum leverage ratio" and
the "interest coverage ratio . "
156. Flowserve executed a credit agreement with § 11 underwriter defendants CSFB and
BofA on 8/8/00, the proceeds of which Flowserve used to help finance the IDP acquisition an d
continue to fund operations . The credit facility contained several financial covenants governing
Flowserve's interest coverage ratio, fixed charge ratio and maximum leverage ratio . As a result of
Greer and Hornbaker's improper accounting which inflated net income and EBITDA, Flowserve wa s
able to hide the fact that it was not in compliance with these various financial covenants contained i n
the credit facility. Each of the financial ratios contains EBITDA as a component of the calculation .
Therefore, by inflating net income, Greer and Hornbaker were able to maintain a false inflated
EBITDA amount large enough to make it appear in their SEC filings that the Company was i n
compliance with each ratio throughout the Class Period when it was not .
157. As defined in the credit agreement, during 3Q01, 4Q01 and 1Q02, the maximu m
leverage ratio required the ratio of total debt to consolidated EBITDA not to exceed 4 .50 to 1 .00, and
the interest coverage ratio required consolidated interest expense to consolidated EBITDA to be no
less than 2 .00 to 1 .00. As Flowserve belatedly revealed in its 2002 Form 10-K/A, the Company was
not in compliance with these financial covenants as of 9/30/01, 12/31/01 and 3/31/02 .
158. The timing and extreme measures taken by Greer and Hornbaker to cover u p
Flowserve's default on its debt covenants is telling . By early 2001, Flowserve's cash flow problem s
were growing worse, and in order to continue on its growth-by-acquisition strategy, Greer an d
Hombaker foresaw that Flowserve would need access to additional debt and/or equity funding soon .
Indeed, by early 2001, Flowserve began to slow its payments to its vendors . CW23 confirmed that
checks cut to pay vendors were ordered by Corporate to be held for at least one week before mailing ,
and as the year progressed, cash flow problems increased . By 4/01, production slowdowns were
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costing the Company badly needed sales, and inefficiencies were drastically increasing the cost to
produce its products. These problems were taking their toll on the Company's financial health,
including the erosion of its gross margins . While these conditions made Flowserve's efforts to
obtain additional funding via the equity market and bank financing ever more imperative, the same
problems were simultaneously eroding the Company's financial position, making it less likely that
such funding could be secured at tolerable interest rates .
159. Greer and Hombaker knew Flowserve could not allow the public to know it defaulte d
on its current debt covenants if it expected to successfully present and sell additional equity in
supplemental offerings . Absent obtaining additional capital from unsuspecting investors, the IFC
acquisition and the debt restructuring necessary to continue to fund operations simply would not
have occurred. Thus, to ensure it would obtain the critical financing it needed, Flowserve inflated its
earnings as alleged herein and fraudulently concealed its noncompliance with its debt covenants in
the quarters immediately preceding and during the 11/16/01 Supplemental Offering . Similarly,
Flowserve was again not in compliance with its debt covenants but concealed this default in all three
quarters immediately preceding the 4/18/02 Supplemental Offering .
160. Had the true state of Flowserve's financial condition been revealed, including its
default on its financial loan covenants, Flowserve's credit ratings would have fallen, impairing its
ability to sell its stock at a price high enough (or at all) to raise enough money to acquire IFC . If the
default had been known to the lenders, the Company would not have been able to renegotiate the
credit agreement on 11/9/01 and again on 5/2/02, at least not on the favorable terms they received .
Both the 11/01 and 5/02 renegotiations yielded amendments loosening various covenants and
allowed Flowserve to carry more debt and interest burdens for longer periods of time ; for example,
the 5/2/02 amendment increased the maximum leverage ratio from 3 .75 to 4 .00 for the period
6/30/02 through 12/30/02, providing a 25 basis point cushion . Additionally, the creditor banks could
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have demanded accelerated payments and could have terminated commitments to supply Flowserve
with further funds, which would have compromised the Company's operations, especially in light of
the cash flow problems mentioned above. Greer and Hornbaker knew these impending risks,
combined with Flowserve's trend of decreasing operating margins, would spell disaster for the
Company and their careers .
5. Flowserve Disguised Recurring Operating Expenses as One-Time Charge s
161 . To artificially inflate its slumping gross profit margins, Greer and Hornbaker
disguised certain recurring operating expenses as one-time charges by burying them in with
integration expense and restructuring expense in the 2000 and 2001 financial statements . Moving
these expenses from operating expenses to a separate, one-time charge created the false appearance
that Flowserve's gross profit vas higher than it actually was . For example, CW7 related that
defendants Greer and Hornbaker specifically requested in an early 2002 meeting in Dallas, Texa s
that operating costs be "dumped" into the integration/restructuring costs . Thus, Greer and
Hombaker unequivocally knew that these expenses were being improperly characterized because
they directed it . Accounting rules do not permit this treatment for obvious reasons . The FASB's
Emerging Issues Task Force ("EITF") Issue No . 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring), and EITF Issue No . 95-3, Recognition of Liabilities in Connection with a Purchase
Business Combination, both explicitly state that in order for a cost to qualify as an
integration/restructuring cost, it must not be associated with or must not benefit activities that will be
continued. Examples of costs that will benefit future activities and, thus, do not qualify as
integration/restructuring costs are systems integration, systems development, relocation and
transitional employees .
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• LJ
162 . CW7 confirmed that Flowserve improperly concealed a material amount of regular
operating costs that benefit future periods as integration/restructuring costs for the IDP acquisition i n
violation of GAAP .
163. By concealing operating expenses as non-recurring charges, such as restructuring and
integration expenses in the 2000 and 2001 financial statements, Greer and Hornbaker were able t o
hide the fact that the downward trend of gross operating margins was worse than reported . In
addition, Greer and Hombaker avoided the disclosure of Flowserve's violation of its debt covenants ,
as cash integration and restructuring charges were not included in calculating EBITDA - a
component of its debt covenant ratios .
6. Flowserve Knew Its Internal Accounting Controls WereInadequate
164. Section 13(b)(2) of the Exchange Act states, in pertinent part, that every reporting
company must: "(A) make and keep books, records and accounts which, in reasonable detail ,
accurately and fairly reflect the transactions and dispositions of the assets of the issuer and
(B) devise and maintain a system of internal accounting controls sufficient to provide reasonable
assurances that . . . transactions are recorded as necessary . . . to permit the preparation of financial
statements in conformity with [GAAP] ." 15 U.S.C. §78m. These provisions require an issuer t o
employ and supervise reliable personnel, to maintain reasonable assurances that transactions ar e
executed as authorized, to properly record transactions on an issuer's books and, at reasonabl e
intervals , to compare accounting records with physical assets . SEC v. World-Wide Coin, Ltd., 567 F.
Supp. 724, 750 (N.D. Ga. 1983) .
165. In addition to the allegations above and the indicators of scienter herein, the IOb- 5
Defendants knew or were, at the very least, deliberately reckless in not knowing that its system o f
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internal accounting controls governing inventory and cost of sales expense during the Class Perio d
was inadequate .9 In fact, Flowserve stated that its independent auditor and the investigation
commissioned by the audit/finance committee concluded that there were significant contro l
deficiencies that constituted material weaknesses in the Company's control environment, specificall y
related to internal controls over the implementation of computer systems, recording inventor y
amounts and related costs, account reconciliation procedures, manual journal entry procedures ,
monitoring of compliance with procedures, financial reporting and disclosure controls an d
procedures . See Item 9A to the 4/27/04 Form 10-K/A and Form 10-K. Moreover, in 2004 ,
Flowserve disclosed in both its 2002 Form 10-K/A and 2003 Form 10-K that it has since begun to
implement no less than seven actions to bring internal controls to an adequate level .
166. In both the 2002 Form 10-K/A and the 2003 Form 10-K, the Company explicitly
admi tted that its independent auditors , PwC, had advised the audit/finance committee more than one
year ago, in 4/03, of "various matters related to inventories at one of [Flowserve's] facilities that
may be considered reportable conditions ." SAS No. 60 requires the auditor to communicate
"reportable conditions" to the audit committee and defines them as "matters coming to the auditor's
attention that, in his judgment, should be communicated to the audit committee because they
represent significant deficiencies in the design or operation of internal control, which coul d
adversely affect the organization's ability to record, process, summarize, and report financial dat a
consistent with the asse rt ions of management in the financial statements ." A reportable condition
9 American Institute of Certified Public Accountants Statement on Auditing Standards("SAS") AU §319.06, Internal Control in a Financial StatementAudit , defines internal controls as"a process effected by an enti ty 's board of directors, management, and other personnel - designed toprovide reasonable assurance regarding the achievement of objectives in the following catego ries :(a) reliabili ty of financial repo rting, (b) effectiveness and efficiency of operations, and(c) compliance with applicable laws and regulations . "
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maybe of a magnitude to have such a detrimental effect on internal control that it may be considere d
a material weakness . SAS No . 60 de fines a mate rial weakness as "a reportable condition in which
the design or operation of one or more of the internal control components does not reduce to a
relatively low level the risk that misstatements caused by error or fraud in amounts that would be
material in relation to the financial statements being audited may occur and not be detected within a
timely period by employees in the normal course of performing their assigned functions ." As noted
above, in 4/03 PwC advised that the various internal control problems did indeed constitute materia l
weaknesses .
167. Flowserve violated § 13 (b)(2)(A) of the Exchange Act by failing to maintain accurate
records concerning its inventories, costs and net income as reported during the Class Period. It
failed to record certain cost of sales expenses in the periods incurred, thereby overstating inventor y
and earnings . Flowserve's inaccurate and false records were not isolated or unique instance s
because they were improperly maintained for multiple reporting periods, from 2000 through the thir d
quarter of 2003 . Accordingly, Flowserve violated §13(b)(2)(A) of the Exchange Act .
168. In addition, Flowserve violated §13(b)(2)(B) of the Exchange Act by failing to
implement procedures reasonably designed to prevent accounting irregularities . Flowserve failed to
ensure that proper review and checks were in place to ensure that it was recording and reporting cos t
of sales expenses in the proper periods and that it was properly valuing inventory . It failed to ensure
that transactions were reported during the Class Period in accordance with its own policies and wit h
GAAP .
169. Flowserve's failure to strengthen its known inadequate internal controls rendere d
Flowserve's Class Period financial reporting inherently unreliable and contributed to the Company' s
inability to prepare financial statements that complied with GAAP . Nonetheless , as detailed above,
throughout the Class Period, the Company regularly issued quarterly and annual financial statements
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without ever disclosing the known existence of the significant and material deficiencies in it s
internal accounting controls and falsely asserted that its financial statements complied with GAA P
when, as alleged herein, it knew the financial statements during the Class Period were not i n
compliance with GAAP .
7. Other GAAP Violations
170. In addition to the GAAP and SEC violations described above, the Company als o
violated the following fundamental GAAP principles :
171 . The principle that interim financial reporting should be based upon the sam e
accounting principles and practices used to prepare annual financial statements was violated (AP B
No . 28, ¶10) ;
172 . The p rinciple that financial repo rting should provide information that is useful to
present and potential investors and creditors and other users in making rational investment, credi t
and similar decisions was violated (FASB CON No. 1, ¶34) ;
173 . The principle that financial repo rt ing should provide information about the economi c
resources of an enterprise, the claims to those resources, and effects of transactions, events an d
circumstances that change resources and claims to those resources was violated (FASB CON No . 1 ,
¶40) ;
174. The principle that financial reporting should provide information about how
management of an e nterprise has discharged its stewardship responsibility to owners (stockholders )
for the use of enterprise resources entrusted to it was violated . To the extent that management offer s
securities of the enterprise to the public, it voluntarily accepts wider responsibilities for
accountability to prospective investors and to the public in general (FASB CON No . 1, ¶50) ;
175. The principle that financial reporting should provide information about an
enterprise's financial performance during a period was violated . Investors and creditors often use
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information about the past to help in assessing the prospects of an enterprise . Thus, although
investment and credit decisions reflect investors' expectations about future enterprise performance ,
those expectations are commonly based at least partly on evaluations of past enterprise performanc e
(FASB CON No . 1, ¶42) ;
176. The principle that financial repo rting should be reliable in that it represents what it
purports to represent was violated . That information should be reliable as well as relevant is a notion
that is central to accounting (FASB CON No . 2, ¶¶58-59) ;
177. The principle of completeness , which means that nothing is left out of the information
that may be necessary to insure that it validly represents underlying events and conditions wa s
violated (FASB CON No . 2, ¶79); and
178. The principle that conservatism be used as a prudent reaction to uncertainty to try t o
ensure that uncertainties and risks inherent in business situations are adequately considered wa s
violated. The best way to avoid injury to investors is to try to ensure that what is reported represent s
what it purports to represent (FASB CON No . 2, ¶¶95, 97) .
179. Further, the undisclosed adverse information concealed by the lOb-5 Defendant s
during the Class Period is the type of information which, because of SEC regulations, regulations of
the national stock exchanges and customary business practice, is expected by investors and securitie s
analysts to be disclosed and is known by corporate officials and their legal and financial advisors t o
be the type of information which is expected to be and must be disclosed .
K. Materially False and Misleading Statements Issued During the Class
Period
1 . The 10b-5 Defendants' False and Misleading StatementsConcerning the Company's Year End 2000 Financial Results
180 . False Statement : At the beginning of the Class Period, on 2/6/01, Flowserve pre-
announced its financial results for the year ending 2000 in a press release entitled "Flowserve EPS ,
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Before Special Items, Up 117 Percent For Quarter, Up 30 Percent For Year." In the press release ,
Flowserve "announced fourth quarter 2000 net income of 50 cents a share, an increase of 11 7
percent compared with 23 cents a share in the fourth quarter of 1999, before special items in bot h
periods ." Flowserve also attached its income statement and balance sheet for the year ending
12/31/00. Among the items not included in the 2/6/01 press release were at least the following :
PwC's audit report dated 2/5/01 ; Valuation and Qualifying Accounts data ; a defmition of "special
items"; Capital expenditures information ; Detailed information regarding the restructuring charges ;
the return on average net assets ; the return on average shareholders' equity; the statement of cash
flows; and breakdowns of the following accounts : inventory, Property, Plant and Equipment, othe r
assets, accrued liabilities, post-retirement benefits and deferred items, debt and lease obligations .
This additional information was disseminated in the Form 10-K filed on 3/29/01 .
181 . False Statement : The press release also stated that "full year 2000 net income was
$13 .2 million, or 35 cents a share . . . ." This statement was false because, as admitted in th e
Restatement, net income for 2000 was $ 10.8 million , or 29 cents a share .
182 . False Statement : The press release quoted Greer as saying: "The integration of IDP
continues to run smoothly and we remain on track to achieve a run-rate of $75 million in annua l
synergy savings by the end of 2001 . In fact, the year end run rate for synergy savings was about $4 4
million versus our original projection of $35 million." This statement was false because th e
integration was not proceeding smoothly and there were significant known dis-synergie s
undermining the savings and increasing costs .
183 . False Statement : The press release further quoted Greer as saying : "Even if sales
were to be flat, we would still anticipate improved results in 2001 due to the expected capture o f
synergies from the IDP acquisition."
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Reasons Why False and/or Misleading :
184 . Pump Production Time Doubles : Greer and Flowserve's statements about synergie s
from the IDP integration on 2/6/01 were knowingly false because defendants knew Flowserve wa s
not capturing synergies from the IDP acquisition but instead was suffering from significant dis-
synergies reducing earnings . According to CW24, immediately after the IDP acquisition in Augus t
2000, Flowserve decided to close down the Huntington Park facility . The Huntington Park facility
produced barrel pumps that used fully-equipped bays where in-house machined parts were
assembled, and large steam turbines were used for testing. When this facility was shut down, the
equipment was dismantled and auctioned . Flowserve was, therefore, forced to establish relationships
with vendors and systems for contracting all of these types of processes to vendors . This caused lead
time for production of barrel pumps to at least double - a significant "dis- synergy" known by the
lob-5 defendants at the end of 2000 . Thus, according to CW24 and CW29, pumps that previously
would have taken 12 to 18 months to produce were taking two and one-half to three years to
complete . According to CW24, this doubling of lead times was a foreseeable consequence of Greer
and Hornbaker's decision to close the Huntington Park facility because, as the witness stated, the
"learning curve for vendors just wasn't there yet," as Flowserve subbed out engineering and
machining work that had been done for years internally . Not every detail of these internal processes
was included in engineering documents, so it was also predictable that parts would be built multiple
times before they were right . The resultant delays and unneeded materials caused costs to escalate .
There was no way for the Vernon plant to produce the IDP orders, requiring outsourcing of these
parts traditionally built in-house . The in- house production traveler document (travelers), operations
sheets, mixes of labor and materials all had to be translated into purchase orders and subcontracted
out to a variety of companies . The assembly and production lines for the IDP barrel pumps and
other products were not yet set up at the Vernon plant, and so it was completely predictable tha t
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process lead times would at least double . The infrastructure was simply not in place to support the
manufacturing of these complex pieces of equipment, which under normal conditions could take u p
to two years . Even contract engineering was subbed out- some to prior contract engineers for ID P
and some to others that were new who were suddenly managing those prior engineers . According to
CW24, engineering drawings and documentation are not always perfect - and were considere d
incomplete or interpreted in different ways upon this subcontracting activity . CW24 believed that
production slowdowns and cost increases were obvious and predictable .
185 . Revenue Decline due to Production Difficulties : Greer and Flowserve's 2/6/0 1
statements about IDP synergies were knowingly misleading . According to CW24, Flowserve' s
revenue and sales projections should have taken into account market reaction to integration problem s
and schedule slippages for existing business . With pump production from the Vernon plant cratering
at least 50% by early 2001 as a result of the problems described above, current customers o f
Flowserve that were formerly IDP customers became wary . These were not problems that could be
hidden from the customer base because of the late deliveries . According to CW24, the custome r
base reacted by not placing new orders . Even though purchasing, procurement and materials
personnel at the Vernon plant were consumed with resolving all kinds of questions and problem s
over inventory, not much of this activity related to new orders . Flowserve was consumed with trying
to figure out how to build what was already in process and was so bogged down that it was nearl y
impossible to start building new pumps . According to CW29 and CW24, the production schedules
of both small and large pumps at the Vernon plant were all slipping . According to CW24, with lon g
lead times for new orders that resulted in an incremental revenue stream over the following four t o
six quarters, it was internally obvious that Flowserve should have easily predicted a decline i n
revenue or revenue growth from '01 to '02, but instead Greer and Hornbaker continued to predict a
15%-20% increase .
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186. False Statement : On 3/29/0 1, Flowserve filed its Report on Form 10-K for the year
ending 12/31/00 with the SEC, including the consolidated financial statements for the year ended
12/31/00. Defendants Greer and Hombaker signed the Form 10-K.
187 . False Statement : On 3/29/01, Flowserve filed its 2000 Annual Report as an exhibi t
to the Report on Form 10-K for the year ended 12/31/00 . The 2000 Annual Report include d
Flowserve's consolidated financial statements for the year ended 12/31/00 .
188 . As Admitted in Restatement : As updated by the l Ob-5 Defendants on 4/27/04, the
financial results included in the income statement and balance sheet and reported in the 2/6/01 pres s
release, the Form 10-K for the year ending 12/31/00, and the 2000 Annual Report were materially
false and misleading and were not reported in accordance with GAAP and SEC Regulation S -X (17
C.F.R. §210.4-01(a)(1)) because, as described in ¶¶129-179, the IOb-5 Defendants knew that : (i) the
financial results originally issued during the Class Period and its public statements regarding those
results were false and misleading and (ii) the financial statements reported during the Class Period
were incorrect based on information available to the IOb-5 Defendants at the time the results wer e
originally reported, as evidenced by the restatement . The following chart summarizes the
restatement (in millions, except per share data) :
2000
Net EarningsEPS (basic)EPS (diluted)
TotalAs Inventory & RestatementPreviously Cost of Sales Other Adjustments Tax AsReported Adjustments Adjustments (pretax) Adjustments Restated
13 .2 (2 .2) (1 .2) (3 .4) 1 .0 10. 80.35 (0 .06) 0 .290.35 (0 .06) 0 .29
189 . As Admitted in Restatement : In the amended Form 10-K for the year endin g
12/31/00, the 1Ob-5 Defendants suggest that the primary reason for the Restatement was th e
Company's inflated inventory amounts and related cost of sales . Specifically : defendants' reporte d
that inventory amounts at two reporting locations in the pump and valve segments of the Compan y
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experienced difficulties associated with converting to new computer systems . As discussed in
¶¶357-362, the computer system was not the true cause of Flowserve ' s falsely repo rted financials,
but Flowserve's amended Form 10-K stated, "[T]he difficulties in executing the conversion and
related reconciliation issues resulted in invento ry amounts not being properly charged to cost of sales
in the appropriate pe riods . "
190 . Greer Was Rewarded for His Fraud : In addition to his $617,490 salary, defendant
Greer reaped an additional incentive based bonus of over $551,048 for his role in Flowserve' s
performance - for a total compensation of $1 .171 million in 2000 .
191 . Hornbaker Was Rewarded for Her Fraud : In addition to her $274,953 salary ,
defendant Hombaker reaped an additional incentive based bonus of over $227,048 for her role in
Flowserve's performance - for a total compensation of almost $508,000 in 2000 .
2. The lOb-5 Defendants ' False and Misleading StatementsConcerning the Company's 1Q01 Result s
192 . False Statement : On 4/24/01, Flowserve published a press release, announcing its
results for 1 QO 1 as "net income of 10 cents a share, excluding nonrecurring integration expenses, fo r
the first quarter of 2001 . This compares with reported net income of 31 cents a share and a pr o
forma net loss of 11 cents a share in the first quarter of 2000."
193 . False Statement : The 4/24/01 press release also incorporated Flowserve's incom e
statement and balance sheet for 1 Q01 .
194 . As Admitted in Restatement : The statements referenced in ¶T192-193 were false
and misleading when made, because as admitted in the Restatement, Flowserve's 1Q01 net loss wa s
understated by nearly $2 million . Furthermore, as described in ¶¶129-179, Flowserve' s financia l
statements for 2000 were materially false and misleading and were not presented in conformity with
GAAP .
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0
3. The 10b-5 Defendants' False and Misleading StatementsConcerning Shelf Registration Statement
195. False Statement : On 5/31 /01, Flowserve filed a prospectus as a part of its Report on
Form S-3 Registration Statement with the SEC . The Shelf Registration Statement and Prospectus
incorporated Flowserve's Annual Report on Form 10-K for the year ended 12/31/00 . Greer and
Hornbaker signed the Shelf Registration Statement on behalf of Flowserve . Hombaker was given
authority to sign and file any amendment to the Shelf Registration Statement .
196 . As Admitted in Restatement : In fact, as described in ¶¶129-179, Flowserve' s
financial statements for 2000 were materially false and misleading and were not presented i n
conformi ty with GAAP . Greer and Hornbaker had inflated Flowserve 's net income by $2 .4 million
in FY00 .
197 . Loan Covenants Limit Management 's Discretion : The Shelf Registratio n
Statement disclosed that the terms of Flowserve's loan covemnts limited management's discretion i n
entering into transaction with affiliates :
The senior credit facilities and the indentures governing our current outstanding debt
contain various provisions that limit management's discretion in operating ourbusinesses by restricting their ability, among other things, to :
(a) Incur additional debt ;
(b) Pay dividends and make other distributions ;
(c) Prepay subordinated debt, make investments and other restricted payments ;
(d) Enter into sale and leaseback transactions ;
(e) Create liens ;
(f) Sell assets; and
(g) Enter into transactions with affiliates .
These limitations on management's discretion further incented Greer and Hornbaker to falsely repor t
their financial statements, and to conceal the fact that they were in violation of their loan covenant s
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at the time of the offerings - because without its lenders' blessing, no Flowserve offerings would
have occurred .
4. The lOb-5 Defendants' False and Misleading StatementsConcerning July Amended Prospectus
198 . False Statement : On 7/2/0 1, Flowserve filed an amended prospectus as a part of it s
Report on Form S-3 Registration Statement with the SEC .
199 . Pumps Fail to Meet Quality Standards : While Greer and Hombaker were filing
SEC documentation for Flowserve to seek capital from investors, they were aware but conceale d
information about Flowserve's failure to meet its contractual obligations and its costly ramifications .
According to CW29, Flowserve was drastically behind on a multi- million-dollar contract with
Southern California Edison ("SCE") for the San Onofre Nuclear Power Plant . Three large sphere-
like pump casings ("spheres") were being built in July 2001 . These were part of an initial order for
six spheres : three having been delivered about two years late on the contract and the second set o f
three to be delivered four years late in 2001 . X-rays were used to verify that the casings met
porosity requirements, and there were other stringent processes, i.e., wall thickness, coatings and
heat treatment for use in a nuclear environment . According to CW29, the contract called for
multiple quality inspections, including inspections by the customer . SCE inspectors refused to
"stamp off' at certain stages of build on these very expensive pieces of equipment, requirin g
Flowserve to rework port ions at its own expense .
200 . Flowserve Loses Progress Payments : According to CW29, the SCE contrac t
provided that, after timely delivery of the first six spheres, there would be follow-on orders for a n
additional ten spheres . After accepting the first three spheres about two years late (in 1999), SCE
had extended delivery dates for the remaining three spheres an additional two years late, making th e
production deadline 2001 . The delays in the schedule caused Flowserve to lose progress payments
under the SCE contract . According to CW29, it was clear by mid-2001 that Flowserve was no t
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going to make this delivery schedule as the casings were still well behind. As a result, Flowserve
knew it would lose the follow -on orders for ten of these multi- million-dollar spheres . In additiori,by
July 2001, it was known internally at Flowserve that the last three spheres were being made for SC E
"for free" - as the build was completed at cost to Flowserve, an ultimate large loss .
201 . Flowserve Loses Progress Payments : According to CW29, there were similar
situations with contracts with Shell Oil Co. and Chevron. By July 2001, Flowserve had begun losing
progress payments . The production problems that occurred on the large pumps Flowserve was
making for Shell included unresolved engineering, process and quality assurance issues . Because of
these problems, Flowserve decided to vend out parts that were not properly machined and to rework
others in- house, which caused increased costs and lead times . According to CW29, like the SCE
contract, the Shell contract provided for follow-on orders for timely delivery, and those follow-on
orders were similarly lost .
202 . Costs Increase : According to CW29, by early 2001, it was obvious to Flowserv e
management that the loss of progress payments, follow-on orders and new orders brought about by
Flowserve's failure to timely deliver pumps was increasing costs, eroding margins and reducing th e
revenue projected .
203 . False Statement : The July Amended Prospectus Shelf Registration incorporate d
Flowserve's Annual Report on Form 10-K for the year ended 12/31/00 . The 12/31/00 Form 10-K
was materially false and misleading for the reasons referenced above in ¶¶129-179 . As discussed
above, Hombaker was responsible for the filing of amendments to the Shelf Registration Statement .
204 . As Admitted in Restatement : In fact, as described in ¶¶ 129-179, Flowserve' s
financial statements for 2000 were materially false and misleading and were not presented i n
conformity with GAAP . Greer and Hornbaker had inflated Flowserve ' s net income by $2 .4 million
in FY00 .
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205 . As Admitted in Restatement : Had the Company reported its 3Q01 financial results
in accordance with GAAP, it would have violated the loan covenants that constituted an event o f
default. Had Flowserve defaulted on its loans, it is probable that the 11/16/01 and 4/18/02
Supplemental Offerings would not have occurred. According to the loan covenants contained in
Flowserve's credit facilities, its creditor banks could have demanded accelerated payments and
terminated commitments to supply Flowserve with further funds, placing the future viability of
Flowserve (and Greer and Hornbaker's careers) in jeopardy as the Company's cash flow problem s
were exacerbated.
5. The lOb-5 Defendants' False and Misleading Statements
Concerning 2Q0 1
206 . False Statement : On 7/24/01, Flowserve issued a press release reporting its ne t
income for the second quarter of 2001 :
The company reported net income, after integration expenses, of $2.6 million, or 7cents a share, in the second quarter of 2001 . This compares with reported net incomeof $12 .6 million and a pro forma loss of $0 .8 million in the prior year period .
For the six months ended June 30, 2001, the company's net income, beforeintegration expenses, was $17.2 million, or 45 cents a share. Including integrationexpenses, the company reported a net loss of $6 .0 million, or 16 cents a share, in thefirst six months of 2001 . These results compare with a pro forma net loss of $4 .8million, or 13 cents a share, and reported net income of $24 .5 million, or 65 cents ashare, in the first six months of 2000 .
207 . As Admitted in Restatement : These statements in the 7/24/01 press release were
false and misleading when made because, as admitted in the Restatement, Flowserve's net incom e
for 2Q01 was inflated by 103 .8%, transforming $2.6 million of net income into a $100 ,000 loss .
Similarly, Greer and Ho rnbaker's press release understated the loss sustained by Flowserve for th e
six months ended 6/30/01 by $4.5 million .
208 . False Statement : The 7/24/01 press release also announced a decrease in Flowserve' s
FY01 earnings guidance . In the press release, defendant Greer stated :
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"Unfortunately, various temporary operating inefficiencies related to theintegration ofIDP have prevented some facilitiesfrom ramping up and achievingthe planned production run-rate, thus negatively impacting the timing ofshipments in 2001," Greer said . "While we have made considerable progress in
resolving these issues overall, two of the plants affected will likely continue tostruggle for the rest of 2001 . Because of the increased shipments in the second halfof this year for the engineered product lines, if these constraints are not corrected
soon, this could adversely impact the company 's 2001 earnings .
"Because of these lingering integration inefficiencies and recent indications of
softness in our chemical-related business, which makes us more cautious, we arereducing our 2001 earnings guidance by as much as 25 cents a share." Greer said .
"This could place our earnings per share, excluding integration expenses, in the rangeof 35 cents to 40 cents for the third quarter and $1 .45 to $1 .65 for the full year. "
Reasons Why False and/or Misleading :
209 . Budget Shortfalls : Although Greer blamed the FY01 decrease in earnings on
"temporary operating inefficiencies" related to the integration, these statements were false and
misleading, because Greer and Hornbaker were aware that the FY01 forecasts were not achievable .
In the fall of 2000, at the time Greer and Hombaker implemented the FY01 Budget Targets, they had
been informed that new orders for engineered pumps at Vernon and Etten-Leur were declining and
would continue to drop at least through the 2Q01 . According to CW6, by the end of June 2001,
actual results were 30% to 40% short of Greer and Hornbaker's budget targets . Although the budget
targets were internally known to be erroneous, Greer directed that no one was permitted to "come off
the target plan numbers until 3Q01 ." CW6 discussed Greer's directive with Vernon plant managers
in about June or July 2001 . The Vernon plant's management explained Greer's position as follows :
"[W]e have to go out to the Street next week and we do not know what to say about revising th e
advice." Documents prepared by a former senior Pump Division executive were given to Greer ,
which set forth the proper method for calculating an achievable forecast for the revenue portion o f
the budget targets . These documents, among others, illustrated to Greer that he was wrong when he
tried to "pass off the problems as a short-term integration problem," and that the problems were lon g
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term and systemic . After reviewing these documents, Greer and Hombaker dispatched someon e
from the corporate accounting office to review the inputs and results presented therein . This person
validated the analysis showing that the budget targets for the balance of 2001 were erroneous . In
fact, CW6 specifically went over the inflation of synergy savings and revenue included in the budge t
target figures with Greer and Hornbaker . CW6 showed Greer and Hornbaker that not looking at
backlog, and instead estimating from historical figures, led (in part) to the erroneous figures . Thus,
Greer and Hornbaker's statements in the 7/24/01 press release were knowingly false and misleading
when made .
210 . Greer and Hornbaker Use Check-Mark Forecasting : CW33 attended financ e
meetings at the end of each quarter and found that Greer and Hornbaker - along with responsibl e
divisional managers - "bought in" to what CW33 called "check-mark forecasting ." By "check-made
forecasting," CW3 3 meant that during reviews of actual financial performance for each quarter, i t
was typical that the forecast had been higher than where the actuals fell, yet projections for the end-
of- year numbers just reflected a steeper rise to meet targets . Althugh CW33 acknowledged that the
fourth quarter was historically the largest for Flowserve in any given year, the forecasting process
was consistently over-optimistic . In CW33's opinion, "in the Sarbannes Oxley world," the
budgeting practices of Greer and Hornbaker fell below the standard required. CW33 stated tha t
these types of overly optimistic forecasting practices "don't fly anymore," that a public company i s
required to be as accurate in forecasting as it should be in historical accounts reporting .
211 . False Statement : The 7/24/01 press release also stated :
In 2000, the company earned 18 cents a share for the third quarter and $1 .35 a sharefor the year, excluding integration and restructuring expenses .
212 . As Admitted in the Restatement : These statements in the 7/24/01 press release wer e
false and misleading when made because, as admitted in the Restatement, Flowserve's earnings per
share for 3Q00 failed to include an additional $0 .02 loss, and its FY00 EPS was overstated by $0 .06 .
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s •
6. The 10b-5 Defendants' False and Misleading StatementsConcerning 3Q0 1
213 . False Statement : On 10/22/01, Flowserve issued a press release announcing its
financial results for the quarter and nine months ended 9/30/01, and issuing guidance for FY02 ,
which called for a "40 to 50 percent" increase in EPS excluding special items . Under the banner
headline "Flowserve Quarterly Earnings More Than Double Over Prior Year," defendant Gree r
commented on the Company's results and future prospects as follows :
"Flowserve performed especially well in the third quarter of 2001 in the face of someextremely difficult circumstances," said Flowserve Chairman, President and Chief
Executive Officer C. Scott Greer . 'The continuing improvements in results andmargins clearly illustrate the benefits from the acquisition of IDP . Thisimprovement was made despite the adverse impact the September terrorist attackshad on our quick turnaround business, where business temporarily stalled after Sept .11 . Were it not for this, our results would have been even better . Also, we'repleased to see progress in addressing integration inefficiencies within our pumpoperations . "
"The increase in bookings primarily arose in our pump business, which we aredelighted to see after our acquisition of IDP," Greer said. .. .
"Following a number of management changes within the Pump Division, I ampleased with the progress we are making in resolving integration issues," Greersaid . I am confident that we are gradually getting back on track and that themajority of these issues will be behind us by year end ."
Reasons Why False and/or Misleading :
214 . Late Shipments : Greer's statements regarding the IDP integration were materially
false and misleading because, according to CW7, at an October 2001 IMT meeting, Greer wa s
informed by the IMT team of the problems experienced at the some of the pump plants involved in
the IDP integration, in particular Vernon and Etten-Leur, Holland . At this meeting, Greer was
informed that the Company was being charged late delivery penalties for the late shipment of pumps ,
as well as warranty charges on pumps, assembled during the integration and did not work once sen t
to customers . CW 1 and CW22 independently confirmed that the pump division was often forced to
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pay liquidated damages because of the Company's failure to make timely deliveries due to th e
serious disruptions caused by the physical movement of manufacturing and sales facilities . CW1
stated that these liquidated damages happened "frequently" with, for example, companies such a s
Fluor and Bechtel According to CW7, Greer was so angered by the poor performance of these
facilities that he stated he "wanted to blow them [Vernon and Etten-Leur] off the face of the earth ."
215 . Poor Performance in Pump Division: Defendant Greer's statements regarding th e
IDP acquisition were also false and misleading because, according to CW7, after the IDP
acquisition, in quarterly meetings, defendant Greer repeatedly expressed displeasure at the results of
the integration . He became "upset" with the performance at the Vernon, California and Etten-Leur,
Holland pump plants and used words to the effect that "I don't understand why Vernon an d
Etter-Leur cannot ship pumps ." In the 10/01 quarterly meeting (which occurred no later than
10/19/01), defendant Greer stated that "If management can't do it [make and ship pumps on time] ,
fire them and get people who can ." Defendant Greer stated at this meeting that he did not want to
hear more excuses about integration problems, he just wanted results .
216 . Inability to Produce Quality Pumps on Time : According to CW6, Greer spok e
publicly about short-term plant closures and head count reductions (and omitted and misled the
public) about the inability of Flowserve to produce acceptable quality pumps and to deliver
shipments on time . These problems were present before the IDP acquisition and continued
throughout the integration period and for some time thereafter .
217 . Greer's Knowledge of Penalties : According to CW7, defendants Greer and
Hornbaker participated in discussions about the problems concerning warranty issues, late delivery
penalties and other customer issues plaguing the Vernon plant . Defendant Greer challenged hi s
managers as to why they didn't just tell customers to "get stuffed ." According to CW26, Greer and
Hornbaker received monthly reports that informed them of the delays on every contract - 100% of
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the pumps being produced at Etten-Leur during this time frame . These reports set forth the result of
the delays as well, including the cost overruns, late charges and lost customers .
218 . Greer's Knowledge of Customer Complaints : According to CW7, in the quarterly
meetings in 4Q00 and 1Q01 -1 Q03, defendant Greer spoke about the fact that both he and the
president of the pump division received calls from major customers complaining about late
shipments, and in particular large customers such as Exxon Mobil .
219 . Cancelled Orders : According to CW12, before the 10/23/01 press release, Greer and
Hombaker knew Japanese customers had cancelled orders for nuclear pumps, and Vernon lost about
10 - 20% of its current commercial business and a significant amount of future business . CW 12 also
confirmed that Shell Petroleum, as a member of a "Preferential Provider Alliance," put the Vernon
plant "on probation," meaning Vernon's listing with the alliance was on probation because Shell was
"very dissatisfied" with Flowserve's performance .
220 . IMT Presentation to Greer: Defendant Greer's statements regarding "progress in
addressing integration inefficiencies" were false and misleading because, according to CW16, Greer
was well aware of the problems facing the pump division after the IDP integration . In July 2001 ,
CW 16 made a presentation to defendants Greer and Hornbaker detailing the findings of the IMT
team and the status of the IDP acquisition. Included in this presentation was a disclaimer of all the
areas that were known to be problems for the pump division, including: late delivery penalties,
expediting fees, increased material costs, among others . Between July and October 2001, the
identified problems intensified .
221 . Disruption and Fundamental Incompatibilities : The statements made by Greer
regarding the progress in resolving integration issues were materially false and misleading,
according to CW1, as there were fundamental incompatibilities between IDP and Flowserve
products that could not be reconciled in the integration . The majority of pumps produced b y
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I . . ~ 0 0
Flowserve are inherently specialized . They are engineered to order, not produced off the shelf.
Orders are usually a complicated system, of which the pump might only comprise 30% of the total
contract . Flowserve and Greer and Hombaker planned to move these highly specialized pump
operations into a new location with little or no drop in production, despite warnings from CW1 to
defendant Greer that this was not possible . In fact, the physical movement of the manufacturing and
sales facilities alone created serious disruptions, causing Flowserve to fail to make timely deliveries
and requiring the Company to pay liquidated damages . Thus, defendant Greer misled the public
when he stated that Flowserve was making progress "in resolving integration issues" and "that the
majority of these issues [would] be behind [Flowserve] by year end . "
222 . Increased Costs Buried in WIP: Defendant Greer's statements regarding the
"continuing improvement in results and margins" were false and misleading because CW25
observed a substantial inventory repo rt ing problem concerning WIP. The WIP reporting problem
stemmed from cost over-runs on the very large, complex pumps produced by Flowserve. CW25
attributed the pump division ' s WIP problems in large part , to Greer and Hombaker 's corporate
culture of not allowing executives to repo rt negative information, such as a failure to make
target/forecast numbers . Executives who reported such failures were publicly berated in quarterly
meetings and sometimes fired . To avoid such chastisement , executives covered -up cost over- nansby
hiding them in WIP . CW25 said that Greer and Ho rnbaker had to know about such cover-ups
because they knew about the underlying facts that cause the cost over-runs , such as the product
failures at the "test stand ," (see ¶226, infra), the inability to make timely shipments and the IDP
integration dis-synergies . According to CW25, there are only three methods for handling a cost
over-run : (1) ask the customer to pay more, which was unlikely to happen in the pump market ; (2)
account for the over-run by showing a reduction in profit or increase in loss - not an option with
Greer; or (3) bury the over-run in WIP . CW25 stated that Greer and Hombaker knew that since th e
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two other options were not used, the over-runs were being buried in WIP . CW12 confirmed that
instead of properly showing cost over-runs as an expense on the profit and loss statement, the over-
run was in effect capitalized as an asset and shown on the balance sheet indefinitely - i.e., as WIP .
223 . Greer and Hornbaker 's Knowledge of Inflated WIP: Defendants' statement s
regarding the "continued improvement in results and margins" were false and misleading because
CW 12 independently confirmed defendants Greer and Hornbaker's knowledge of the cost over-rum
through Quarterly Meetings where Greer and Hornbaker "knew the numbers for each facility ."
According to CW 12, defendants Greer and Hombaker would drill down into the numbers for each
facility, and into the underlying components of the numbers for sales, cost of sales and earnings .
CW12 also confirmed that the estimates and actual results from each location received a detaile d
screening from the corporate team, especially Greer and Hombaker . According to CW 12, there was
no doubt that defendants Greer and Hornbaker knew about the cost over-runs because they always
"pushed" back when informed of negative results and when confronted with cost over-runs and/or
untimely shipments that undermined the quarterly numbers, would demand of the executive making
the presentation "what are you putting in its [the failed job's] place to make the forecast numbers ."
224 . Transfer of WIP : Part of the WIP problem came during the I DP integration, when a
partially completed job was shipped in WIP from other plants, these partially built, large circulatin g
vertical pumps arrived in crates looking like "jigsaw puzzles ." CW25 stated that this was the
situation beginning in the fall of 2000 and continued through 2001 . According to CW 16, shipping
WIP inventory from the Phillipsburg, NJ pump plant (which was closed) to the Vernon plant (th e
receiving plant), amounted to about $5 million and comprised several large jobs . Shipping the WI P
resulted in late shipments to customers, and the same was true for WIP transferred from th e
Huntington Park plant (which was closed) to the Vernon plant. According to CW 16, the Verno n
plant "hardly ever made timely shipments and [as a result] had a backlog [of late orders] . "
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225 . Transfer of WIP: CW32 also confirmed the difficulties associated with the transfer
of partially complete pumps . According to CW32, the transfer of jobs as WIP from Huntingto n
Park , CA and Phillipsburg , NY to Vernon increased the amount of time and money it took t o
complete the jobs . The extra time required to finish the jobs meant that shipments were late ,
requiring the payment of late shipment penalties, and also lost the Company business . The extra
manufacturing and engineering labor, and perhaps even some extra material, increased the cost o f
completing the job .
226 . Failure Rate of Pumps : According to CW25, the WIP problem also resulted fro m
the high failure rate of Flowserve's complex pumps . The tight specifications for the complex pumps
that Flowserve made left little margin for error. To win an order from a customer, it was necessary
to assume that the pump could be built to pass the vibration (and other tests) and quote a price to th e
customer that would provide a 10% profit, for example . According to CW25, in the not uncommon
event that the virtually completed pump failed one of these tests, the extra cost of finding and fixing
the cause of the failure and retesting the product until it passed could wipe out the 10% profit and
turn it into a 30% loss . And the cost of late shipment penalties added to the loss . All of these cost
overruns were not properly reported to the public, but were instead buried in WIP . The high failure
rate of these pumps was confirmed by CW12, who stated that such failures were "common. "
227 . WIP Transferred Between Plants : Greer's statements regarding the continued
"improvement in results," "integration inefficiencies" and "progress . . . in resolving integration
issues" were false and misleading because, according to CW33, every plant at Flowserve was a "job
shop," in that it contained all of the technology, customer relations, engineering drawings an d
working knowledge (described by CW33 as the legacy construction knowledge ) for the items
traditionally manufactured in that plant . CW33 stated that the only way to make a successful
transfer of WIP in the Flowserve job-shop environment would have been to move inventory at a
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clean break, where old jobs accepted and begun in the old plant would be completed there, whil e
new jobs could be built from start in another plant . According to CW33, the problems that occurred
involved transferring of WIP jobs where the job had been accounted for in a legacy system existin g
at the old plant, and Flowserve attempted to integrate these into a new plant without all of th e
necessary information being input into the new MRP system - BAAN. CW33 said that much of
pump production "just languished " as a result , creating a "nightmare " for the company to produce
pumps at all, let alone on schedule. As a result, the integration was impossible to achieve in the tim e
allotted .
228 . Obsolete Inventory Included in Project Inventory : Defendant Greer's statement s
regarding "continued improvement in results and margins" were false and misleading, because
according to CW30, Flowserve's Vernon plant could not get any pumps delivered, costs were
escalating without any ability to track actuals or make realistic projections, and it seemed to the
witness that "project inventory" was overstated at Vernon in order to create a false, but better
financial picture . CW30 stated that there was a "huge problem" in keeping the records straight in the
facility, and that consolidation with IDP made matters worse . Large parts could not be located (e .g .,
a 10' x 4" shaft) . Ultimately, CW30 personally created a location in the warehouse for "obsolete
inventory," where there was no expectation that anybody would be able to use it . CW30 physically
segregated these materials and created different areas to store it . CW30 learned, however, that the
Vernon controller was including these large amounts of obsolete inventory as usable production
materials, or work in process . CW30 confronted the controller on this issue at direct times after the
physical count of inventory was conducted in later 2000 and during 2001 . Vernon's controller too k
the position that if he did not personally know there was no use for the inventory, then he was goin g
to carry it on the books . The Vernon plant continued to carry this as an asset for the next three years ,
and through all annual physical counts, and should have been timely reserved as obsolete each year .
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Then, since these "assets" were originally identified in 2000, and had not been used in three years as
of later 2003 , the amount finally had to be adjusted because it was too visible . According to CW30 ,
there was a "huge inventory" at the Vernon plant, and that the dollar value of that which was
obsolete and should have been reserved in 2000, would be "in the millions ."
229 . Obsolete Inventory included in Project Inventory : CW30 is familiar with
accounting treatment of inventory, and said the "conservative approach" is to recognize depreciatio n
when the future value decreases . CW30's manager avoided reporting the obsolete inventory by
calling it "project inventory" - a category of inventory that is purchased specifically for a particula r
job. According to CW30, there were no records to demonstrate that this obsolete inventory had been
purchased for any specific order in production at the plant .
230 . Greer's Knowledge of the Cost Overruns : Defendant Greer's statements regarding
the "continued improvement in results and margins" were false and misleading, because defendan t
Greer had actual knowledge of the cost overruns faced by the pump divisions . According to CW30,
defendant Greer came to the Vernon plant with a team from corporate in April or May of 2001, and
met with all of the Vernon plant managers, including CW30 While details of problems were
discussed- especially the bog down in production due to BAAN and integration problems, Greer' s
response was to consistently question whether the root of the problems was "a system or th e
management personnel ." According to CW30, Greer's approach to the issues at the Vernon plant
was to simply say "fix it" if it were a system problem, and that he (Greer) would personally deal
with it if it turned out to be a personnel issue . Vernon plant management consistently told Greer that
the problems were systemic and demonstrated various work-around plans that were being developed
to deal with the BAAN bog down . The discussions with defendant Greer emphasized the costs an d
various plant management made statements to the effect that the plant was still trying to "get a
handle" on that issue. CW30 stated that there could have been no question to plant management, th e
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Pumps Division, or senior executives that production would recover any time soon , and that cost
figures were hard to estimate . According to CW30, the escalating cost issue was discussed in both
the April or May 2001 meeting with defendant Greer at the plant , followed up by a second meeting
that occurred in the summer, just two or three months later . Defendant Greer took a personal interest
in the Vernon plant , according to CW30, because "he didn ' t like the numbers" and "there was no end
to the problems. "
231 . Defendant Greer Pressures Pump Division : Defendant Greer's knowledge o f
problems faced by the pump division was also confirmed by CW28 . CW28 stated that it was clear
the Flowserve pump division was facing extreme problems throughout the Class Period . Defendant
Greer met with Shane Dryanski, a VP in the pump division, on numerous occasions where,
according to CW28, defendant Greer would often yell at Dryansky, "That's not good enough!" and
"go fix it!" - the kinds of directives that cause CW28 to believe that defendant Greer was directing
Mr. Dryansky to change accounting and financial results .
232 . Profit Margins Nose Dive : Greer's statements regarding the "continued
improvement in results and margins" were also false and misleading because, according to CW33 ,
after the acquisition of IDP in 2000, there were two primary components associated with the
integration that were important to the success or failure of the merger : large pump manufacturing
and parts and services . Large pump manufacturing is "contract jobs," the specially ordered high-
priced pumps, where there are low margins due to competition . The second major area of interest i n
the IDP acquisition was "parts and services," which had higher margins and held the promise o f
accelerating Flowserve 's presence in the industry and earnings . According to CW33, the desired
mix between these two "just never happened," which caused Flowserve to rely more heavily on sales
of the large contract jobs to meet earnings projections . Due to the integration problems, however,
Flowserve could not produce these pumps on schedule . According to CW33, whenever pump
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manufacturing takes longer, the costs rose substantially, which caused margins to "take a nose dive . "
With the very low margins involved in manufacturing these units anyway, Flowserve's productio n
problems caused costs to rise and also caused the company to "get in trouble quick ." CW33 said
these trends were "very evident" during 2001, and there was little or no improvement during 2002 .
Moreover , according to CW33, because the high margin parts and service business was "drifting off '
rather than taking off, Flowserve had to spread all of the unchanging overhead across the lower
margin OEM orders . As a result, profit margins dropped below expectations and made overhea d
costs appear to rise .
7. The lOb-5 Defendants' False and Misleading StatementsConcerning FY01 and FY02 EP S
233 . False Statement : Also in the 10/22/01 press release, defendant Greer announced a
40%-50% increase in EPS, excluding special items, for fiscal year 2002 :
"Presently, we anticipatefull year 2001 earnings per share, excluding special items,will be within today's range of estimates as reported by First Call, assuming nofurther deterioration in our quick turnaround business," Greer said. `Although weare still preparing our plans for next year, we initially expect full year 2002earnings per share to be up 40 to 50 percent compared with 2001 earningsexcluding special items . . . . "
Reasons Why False and/or Misleading :
234 . Pump Division Internally Lowers Forecast : According to CW 16, defendant Greer' s
statements regarding the 2001 earn ings per share, as well as the increase in ea rnings for the 2002
fiscal year were materially false and misleading because corporate management, including
defendants Greer and Hornbaker, had forced Flowserve's divisions into an aggressive forecast plan
that required very high budget (including revenue growth) targets . The forecasts were made monthly
and covered the month ahead, the full year, and the 12 months ahead from the current year . In
September 2001, the pump division, accounting for approximately half of Flowserve's sales in 2001 ,
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lowered its forecast for 2001 . Flowserve's 10/22/01 press release, including Greer's statement, is
inconsistent with this internal reduction .
235 . Overly Aggressive Forecasts : According to CW2, throughout the Class Period,
defendant Greer "force fed" each of Flowserve's businesses a budget that included a 15% annua l
growth in "top line" sales revenue irrespective of business conditions . Each unit's budget forecast
was based upon this 15% plan. To justify such a forecast, division managers were required to list all
the things that must happen to obtain a 15% growth forecast, and then pretend all of those things
would happen. Managers were forced to make these overly optimistic assumptions even though they
knew that in reality, based on "actuals," many of those things probably would not happen .
Defendants Greer and Hornbaker also knew the lack of reasonable basis for these growth forecasts
based on the monthly and weekly sales reports from each facility. CW2 explained that if managers
submitted a forecast that was not consistent with Greer's 15% Growth Plan that the forecast would
be returned and the manager would have to redo the forecast to make it consistent with Greer's 15%
Growth Plan . According to CW25, the managers knew that they would lose their jobs if they failed
to follow Greer's mandate, even though the reasons for a lower forecast were well justified . The
same was true of Flowserve's accountants, and, according to CW25, this behavior accounted for the
high turnover rate among Flowserve accountants .
236 . FY2002 Forecasts Without Logic: Defendant Greer's statements regarding the
FY02 forecasts were false and misleading because, according to CW30, in 2001, Vernon may have
been responsible for only about $80 million in revenue - primarily based upon pumps that it was
finishing from 1999 or early 2000 orders . This is because of lead-time in pump production, where
the larger and high-priced pumps take about a year to build under normal circumstances . Production
of new orders from the time that BAAN was implemented, followed by the integration, presented an
even more dismal picture. According to CW30, Vernon "couldn't get anything out," and the facilit y
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could not coordinate the delivery of materials in order to get pumps built. There were pumps on the
floor that were half complete, but those were shoved aside to start others where parts had come in .
CW30 described it as a "chaotic mess" and that there was "no logic" to the 2001 "rosy forecasts" for
2002 .
237 . 2001 Plan Overly Aggressive : Defendant Greer's statements regarding full year
2001 estimates were false and misleading because , according to CW30, with regard to costs, even
though there were "overruns on everything," the corporate targets for costs were "very aggressive ."
The annual budget for the Vernon plant in 2001 - a function of interchanges between corporate
executives, division and plant management - were commensurate with an expeditious
implementation of BAAN, integration of facilities and consolidation of plants . According to CW30,
none of these things were occurring or even improving to suggest such unrealistic cost targets could
be achieved.
238 . Improper Accounts Receivable : The statement that the company had funds
"adequate to fund capital expenditures, working capital needs, service debt and make loan
repayments" was also materially false and misleading because, according to CW 17, the Company
was improperly recording accounts receivable to make their financial position look stronger . In June
2001, CW1 7 discovered improper accounts receivables recorded on Flowserve's books and brought
it to the division management's attention. A customer contract with Mobil Oil ("Mobil") provided
for payment to Flowserve of a performance bonus conditioned upon Flowserve's meeting certain
quality and delivery goals . CW17 learned that a $250,000 performance bonus was booked as a sale
in June 2001 even though Mobil had not yet determined that Flowserve had met its goals, nor had it
acknowledged the bonus payment as due and owing to Flowserve . When CW17 questioned the
accounting and brought the problem to the attention of upper management, CW 17 was informed tha t
the instructions to book the bonus as a sale came directly from the head of the Seal Division. Mobi l
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then contested the performance bonus and CW 17 requested that the $250,000 receivable be reversed.
Instead, CW17 discovered that the receivable was instead doubled, making a total of $500,000 of
improperly recorded accounts receivable, which was shown as overdue by 90 days . In September
2001, CW 17 learned that Mobile had recently agreed to pay $200,000 to Flowserve as a performance
bonus . The agreement provided for payments in installments of $50,000 over a period of eight
months beginning 1/1/02 . When CW17 reviewed the September books, the Mobil account s
receivable had increased to $550,000 ($500,000 and then $50,000 for the "first payment") . CW1 7
participated in a conference call in October 2001 to discuss the Mobil receivable. The head of th e
seal division retorted , "if you think I 'm going to take $550 thousand off my bo ttom line, you are
f*****g crazy ." Thus, Flowserve receivables were fraudulently inflated .
239 . Dis-synergies : According to CW1, M&A Partners, a consultant hired to assist
Flowserve in the IDP integration, told defendant Greer that inefficiencies resulting from acquisition s
are well known and usually account for a 20%-30% decrease in revenue. As a result, the IMT and
M&A Partners created the original integration plan that included a 20% drop in revenue for the dis-
synergies that Flowserve would experience during the acquisition/integration process . This model
was revised by Fbwserve's controller and defendant Hornbaker, at defendant Greer's direction, to
remove the 20% allowance for these dis-synergies . A large factor behind the revisions of the
integration plan was to gain the Board's approval for the acquisition price of IDP. Thus, while
Flowserve may have been experiencing an increase in results and margins, it was misleading t o
suggest it "clearly illustrate[d] the benefits from the acquisition of IDP" and failed to disclose to the
public that there were severe inefficiercies and troubles also besetting the acquisition .
240 . Dis-synergies : CW 1 had tried to convince defendant Greer, beginning in 4/01 an d
continuing through 7/01, that it was important to include the 20% revenue reduction allowance in th e
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internal and publicly disclosed forecasts . Greer ignored these warnings and insisted on ignoring th e
dis- synergies associated with the IDP acquisition .
241 . False Statement : The 10/22/01 press release incorporated Flowserve's 9/30/0 1
income statement and balance sheet .
242 . In Violation of Loan Covenants : Flowserve 's statements regarding the 9/30/0 1
income statement and balance sheet were false and misleading because, as admitted in th e
Restatement, Flowserve was in violation of its loan covenants as of 9/30/01 . Greer and Hombaker' s
false report of Flowserve's financial condition for 3Q01 concealed this fact .
243 . False Statement : The 10/22/01 press release also announced :
Net income was $5 . 8 million , or 15 cents a share, in the third quarter of 2001compared with a pro forma net loss of $23 .4 million, or 62 cents a share, in the prioryear period . The company reported a net loss of $13 . 0 million, or 34 cents a share, inthe third quarter of 2000 .
244 . False Statement : The 10/22/01 press release also included Flowserve' s incom e
statement and balance sheet for 3Q01 .
245 . As Admitted in Restatement : These statements referenced in ¶¶243-244 were fals e
and misleading when made, because as admitted in the Restatement, Flowserve's net income fo r
3Q01 was overstated by 50 .3%, reducing net income by $2 .933 million that quarter alone .
8. The lOb-5 Defendants' False Statements Concerning 3Q01Funding and Compliance with Debt Covenants
246 . False Statement : By early November, Flowserve was running out of money and was
in violation of its debt covenants, although it stated otherwise to the market . On 11/2/01, in it s
Report on Form 10-Q filed with the SEC, Flowserve stated :
The provisions of the credit agreement require the Company to meet or exceedspecified defined financial covenants . These covenants include a leverage ratio, aninterest coverage ratio, and a fixed charge coverage ratio . Further, the provisions ofthe credit agreement require limitations or restrictions on indebtedness, liens, sale
and leaseback transactions, asset sales, limitation of restricted payments, capita l
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expenditures and other customary restrictions . As of September 30, 2001, theCompany is in compliance with these covenants .
247 . In Violation of Loan Covenants : The statement that Flowserve was "in compliance
with these covenants" as of 9 /30/01 was materially false and misleading . Only by falsely inflating
Flowserve's financial condition were Greer and Hornbaker able to conceal that Flowserve wa s
outside of certain required ratios . As admitted by Flowserve in the Restatement, "due to the
restatement that at September 30, 2001, . . . [Flowserve] did not comply by 25 basis points or less
with two financial covenants . . . ." The two financial covenants violated were the leverage ratio, fo r
which the maximum allowed was 4 .50 to 1 .00, and the interest coverage ratio, for which the
minimum permitted was 2 .00 to 1 .00 .
248 . False Statement : The 11/2/01 Form 10-Q filing also stated that :
The Company currently believes that internally generated funds and fundsavailable under its bank agreement will be adequate to fund capital expenditures,working capital needs, service debt and make loan repayments . The Companybelieves it also has access to additional sources of funds in the event that such funds
are required.
Reasons Why False and/or Misleading :
249 . In Violation of Loan Covenants : As admitted in the Company's Restatement ,
Flowserve was in violation of its debt covenants as of 9/30/01 . Greer and Hornbaker's false report
of Flowserve' s financial condition concealed this fact .
250 . Cash Flow Difficulties : Defendants' statements regarding its internally generated
funds being "adequate" were false and misleading because, according to CW 17 in September 2001 ,
the Company made a cash collection deal with a company, Straton, Inc., that owed Flowserve
money. Although CW 17 considered this a "ridiculous deal" and although both CW 17 and his/he r
superior agreed that it was unnecessary from a credit perspective to give the customer a 50 %
discount and that the customer "was good for the money and would pay the whole amount," CW 1 7
was forced to make the deal with the customer and take $500,000 on a $1 million account in order to
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have the cash by the end of September . Thus, Flowserve's cash-poor condition forced the Company
to make decisions concerning receivables that impinged upon its profitability . The statements
regarding Flowserve's internally generated funds and funds available under its bank agreement being
"adequate" were false and misleading because Flowserve did not disclose to the market that it was
strapped for cash and in violation of its loan covenants .
9. The lOb-5 Defendants' False Statements Concerning theNovember Prospectus Supplement
251 . False Statement : On 11/16/01, the 1 Ob- 5 Defendants filed a Prospectus Supplement
to the 7/2/01 Registration Statement on Form S-3, filed with the SEC. The November Prospectu s
Supplement incorporated Flowserve's false Annual Report on the Form 10-K for the year ende d
12/31/00 .
252 . As Admitted in Restatement : As detailed in ¶¶129-179, and admitted by the l Ob- 5
Defendants in Flowserve's Restatement, the 12/31/00 Form 10-K and associated financial statement s
were materially false and misleading at the time they were made. The false statements in th e
12/31/00 Form 10-K were also false and misleading at the time Flowserve issued the November
Prospectus Supplement .
253 . In Violation of Loan Covenants : The 12/31/00 Form 10-K was false and misleading
when made because, as admitted by the lob-5 Defendants in their Restatement, Flowserve woul d
have been in violation of its debt covenants at the time of this press release and had that bee n
disclosed, it is likely Flowserve would not have been able to complete the offering .
254 . False Statement : In the November Prospectus Supplement, defendants stated onl y
that, "[a]ffiliates of certain of the underwriters participate in our s ✓nior credit facilities," and
identified those underwriter affiliates only in a document incorporated by reference in anothe r
document incorporated by reference in the Prospectus .
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'.q I . 9 0
Reasons Why False and/or Misleading :
255 . Underwriters ' Conflict of Interest: The statements regarding the affiliates o f
underwriters participating in the senior credit facilities were false and misleading because the
underwriters in connection with Flowserve's November offering, BofA and CSFB, were paid nearly
$2 million each in underwriter fees by Flowserve . The November Prospectus Supplement failed to
disclose that BofA's commercial banking arm was the Swingline Lender, Administrative Agent and
Collateral Agent for Flowserve's 8/8/00 Credit Agreement, its senior credit facilities . Nor did it
disclose that CSFB's commercial banking arm was the Syndication Agent of Flowserve's senior
credit facilities . Thus, Flowserve's statements regarding the affiliates of the underwriters, and its
double incorporation of documents by reference was false and misleading because the general public
would have no way of knowing of the conflict of interest existing between Flowserve's underwriters
and the affiliated holders of its senior credit facilities .
256 . False Statement : On 11/16/01, the Company's November Prospectus Supplemen t
pursuant to the Prospectus dated 7/2/01, filed with the SEC, made the following representations
concern ing the Company' s "stable, consistent aftermarket revenue" streams :
A large installed equipment base is critical to securing on-going incrementalrevenues as industry analysts suggest that a high percentage of the total lifecycle costof a pump consists of aftermarket products and services, such as replacement parts,mechanical seals and maintenance. In addition, our installed base continues torequire maintenance and the installation of replacement parts . This provides us witha steady source of aftermarket revenues at higher margins than our originalequipment business. When outsourced, a majority of replacement parts orders andaftermarket services business is awarded to the original equipment manufacturer .Our acquisition of IDP nearly tripled our installed pump base and we arecontinuing to leverage our extensive service network ofapproximately 150 service
and repair centers to cross-sell aftermarket products and services to IDP's pumpcustomers.
Reasons Why False and/or Misleading :
257 . Unprofitable Revenue Mix : Statements in the November Prospectus Supplement
regarding a "steady source of aftermarket revenues" were false and misleading because, according to
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CW7, it failed to disclose that IDP's business mix consisted of 60% OEM sales and 40% aftermarke t
sales . This distribution of revenue centers was not a profitable mix . IDP focused on large OEM jobs
(over $500,000) that were loss leaders (which resulted in zero or negative gross margins) to bring in
the more profitable aftermarket sales . Aftermarket sales needed to account for at least 45% of the
revenue mix to make up for the losses on these large OEM sales. Thus, while it is true that the
acquisition of IDP resulted in a substantial increase in the installed pump base, it was misleading to
state that this acquisition provided the Company "with a steady source of aftermarket revenues at
higher margins than our [OEM] business" without disclosing that the IDP's overall mix resulted in a
net loss.
258 . False Statement : The November Prospectus Supplement also stated :
Complete the Integration of IDP and Capitalize on Operating Synergies . We havesubstantially integrated IDP into our business and have begun to capitalize on thesignificant operating and financial benefits of the acquisition . As of September 30,2001, we have generated cost savings of approximately $66 million since thecompletion of the IDP acquisition . This amount represents an annual run rate ofapproximately $90 million, which is 20% higher than our originally announced targetof $75 million . We have achieved, and are continuing to achieve, cost savings andoperating synergies through : (i) eliminating redundant administrative overhead, (ii)cutting overlapping sales personnel, (iii) shifting production to lower cost facilities,
and (iv) realizing volume procurement savings and other opportunities .
Reasons Why False and/or Misleading :
259 . Stock Offering Due to Integration Difficulties : According to CW6, defendan t
Hombaker admitted at a meeting of the IMT on 1/22/02 in Dallas that the public offering was only
necessary because Flowserve had failed to meet its integration targets . At the meeting, in arguing
that IMT had not met its targets for the integration (for the cost saving synergies, the cash generated
and the cost outlays expended to achieve the synergies and cash ), Hornbaker cautioned that the
following statement was "for this room only" and admitted that if tie Company had met its
integration targets, it would not have issued stock through the November Prospectus Supplement .
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The troubles besetting the integration and the true reason behind the stock offering was never fully
disclosed to the public .
260 . Stock Offe ring Due to Integration Difficulties : CW7 independently confirmed the
occurrence of the 1/22/02 Dallas meeting where Hornbaker acknowledged that had it not been for it s
poor operating results, Flowserve would not have to go to the Street to get more capital . According
to CW7, defendant Hornbaker meant that this stock offering was necessary to avoid violating
Flowserve 's loan covenants . CW7 confirmed that the true reasons behind the November stock
offering, the poor operating results of Flowserve and Flowserve's loan covenant violations, were
never disclosed to the public .
261 . Flowserve realized net proceeds of approximately $163 million from the sale of stoc k
pursuant to the November 2001 Prospectus Supplement .
10. The lOb-5 Defendants' False and Misleading Statements in theYear End 2001 Press Releas e
262 . False Statement : On 2/4/02, the Company issued a press release announcing it s
financial results for the quarter and year ended 12/31 /01 . The press release stated in pertinent part as
follows :
"Considering the disruption caused by the plant consolidations, the softer economyand the impact of Sept . 11 on our quick turnaround business, I am pleased with our
results," said Flowserve Chairman, President and Chief Executive Officer C . ScottGreer. `I am particularly pleased with the level of fourth quarter shipments fromour pump plants, where we have been able to ship out the transferred backlog. . . . "
"While bookings in the first half of 2002 could be flat to slightly down, the outlookfor second half bookings is up due to increased project activity, such asdesulfurization," Greer said. "That said, we still feel strongly that with theharvesting of the full year of captured synergies and the operating improvements wehave made, we can expect to report first quarter 2002 earnings per share in therange of 27 to 31 cents compared with the year ago quarter 's 10 cents, beforespecial items, and reported net loss of 22 cents . We continue to expect to reportfullyear 2002 earnings per share in the range of $1.90 to $2.30 . The estimates for2002 include the effects of the SFAS 142 accounting pronouncement . "
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Reasons Why False and/or Misleading :
263 . Dis-synergies Discussed : Defendant Greer's statements about being "pleased wit h
the level of fourth quarter shipments from [Flowserve's] pump plants" and the forecast of FY02 EPS
of $1 .90-$2.30 were misleading and knowingly false when made. According to CW7, during the
quarterly operations meeting of the pump division held in January 2002, at which defendants Greer
and Hornbaker, other senior corporate management officials and the managers of the pump divisions
throughout the world were present, the financial impact of the dis-synergies or inefficiencies caused
by the plant closures and transfer of equipment, inventory and personnel to the receiving facilitie s
was discussed .
264 . Downturn in Profitable Pump Sales : According to CW7 and CW9, the dis-
synergies caused by the closure of the Durco pump plant at Dayton, Ohio at the end of 2000 and th e
transfer of that production to the Chesapeake, Virginia facility were discussed . Durco pumps were
Flowserve's number-one seller . Prior to closure, the Dayton pump plant was very profitable ,
producing approximately 50% of-the profit earned by the pump division. Dayton's sales revenue
was about $100 million, about 40% of which was aftermarket sales with gross margins in the 50%-
60% range. Dayton's OEM sales margin ranged between 20% and 25% . In comparison, Verno n
and Taneytown, Maryland OEM sales only broke even, and IDP's operated at a net loss . In addition,
the (i) loss of personnel (very few Dayton pump facility employees were willing to relocate to th e
Chesapeake facility) meant the loss of institutional knowledge about what made Dayton
extraordinarily profitable and (ii) failure of the Chesapeake plant to make timely delivery of proper
quality Durco pumps resulted in loss of customers and revenue, as predicted by IMT and M&A
Partners . IMT and M&A Partners discussed with Greer and Hornbaker that these dis-synergies ha d
resulted in a 30% decline in Durco pump sales from the combined plants .
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265 . Incompatible Operations : According to CW 10, Durco brand pumps, which are
Flowserve's number one seller, are used to move products including petroleum, nuclear waste and
petrochemicals. In contrast, the IDP pumps produced at the Chesapeake facility were used to move
products such as water, steam and wastewater . These two contrasting types of pumps use different
materials, technologies, production methods and testing protocols . Consequently, the two types of
operations require different types of expertise . The Chesapeake employees had never manufactured
Durco pumps, and Flowserve did not provide the Chesapeake facility with the personnel or trainin g
essential to the Durco pump production process . The new Durco pumps did not work and/or wer e
delivered late with a severe impact on customer satisfaction and retention levels .
266 . Plant Dis-synergies : Similar dis-synergies caused by the closure of the Belgian
Durco pump facility and the transfer of operations to the Newark, United Kingdom plant were
discussed . The Durco pump business had been profitable in Belgium . Even though the move from
Belgium to Newark had provided a cost savings, the Newark plant failed to meet delivery schedules
and lost customers, and the revenue from Durco sales declined by approximately 50% from the
combined plants .
267 . President's Report Details Pump Division 's Disruption : Defendants Greer and
Hornbaker had further knowledge of the falsity of their 2/4/02 statements regarding bookings ,
backlog and the anticipated EPS because of the 4Q01 and FY01 President's Report, submitted to
Greer and Hornbaker in January 2002 . This report, the pump division's comments on bookings
included disclosures that:
Bookings Down : "EMA industrial experienced a significant slowdown in orderintake in Q4[01 ], with OE falling 30% short of Plan and AM some 22% adverse . AllBU's apart from Arganda experienced a similar problem . In particular, CPI/GIbusiness is seriously affected in Newark and Amage . Of serious concern is theslowdown in AM business which is typically short lead time, high margin and willresult in a weaker 2002 Q1 opening backlog ." The report went on to conclude that"Newark's integration difficulties have also resulted in some lost business as a resultof poor on time performance ."
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Backlog Levels of Concern : "On a negative note, the lack of incoming AM orders
resulted in Newark's AM shipments being some 24% down against Plan ." Thecomments on the backlog in the pump division concluded, "[bJacklog levelsfor 2002are of serious concern , particularly in Newark, where order intake has been sluggish
for several months . "
Gross Margin Being Eroded : The report commented that "[o]verall shipment
volumes were 10% adverse to Plan in Q4 . As a result fixed manufacturing expensesrepresented a greater proportion of total cost of sales and lead to eroded margins ."According to the report, on a fiscal year basis, Newark and Hamburg had struggled
all year to achieve their planned efficiency levels, and Newark had clearly suffered asa result of the Durco transfer . The Hamburg plan had lost margin as a result of theproduction inefficiencies directly attributable to a very high backlog .
Increased Collection Period : The reported concluded that Newark's days sales
outstanding, or the plant's average collection period, had been negatively impactedby poor invoicing integrity, staff turnover and increased pressure on credit termsbrought about by the Durco transfer .
Inventory Levels Inflated : The report stated that the inventory levels throughout theEuropean plans of the pump division have "tended to exceed the Plan and partlyreflect the higher levels of WIP brought about by planning and supply chaindifficulties . Inventory was in general tending to take too long to process through[Flowserve's] facilities. Newark was a prime example of that fact ."
268 . False Statement : The 2/4/02 press release went on to state :
Sales in the fourth quarter of 2001 were $539 .3 million compared with $541 .7million in the year ago quarter. The fourth quarter, traditionally a strong shippingquarter, was impacted in 2001 by the decline in bookings related to MRO activities .
Bookings in the fourth quarter of 2001 were $452.9 million compared withreported bookings of $502.3 million in the year ago quarter . However, thecompany's backlog increased to $662 .8 million at Dec . 31, 2001 from $659 .3 millionat the end of the prior year .
Reasons Why False and/or Misleading :
269 . Flowserve Misses Internal Targets : Defendant Greer's comments regarding
Flowserve's sales and bookings in 4Q01 were misleading because, according to CW2, Greer knew
that Flowserve had missed its internal targets for the year . In fact, Flowserve's 2001 results were a t
least 5% below Flowserve's internal forecast . Rather than reporting the true outlook known on and
before 2/4/02, Flowserve reported the comparative annual bookings, which presented an inflate d
picture due to the intervening acquisitions ' production execution problems. Defendants Greer and
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Hombaker were aware, based on quarterly reviews held with each division, that actual numbers were
declining in both 2000 and 2001 and that the forecast revenues were not being met . Therefore,
Greer's comments were misleading because they were undermined by his knowledge that Flowserve
missed its growth forecasts .
270 . False Statement : The 2/4/02 press release went on to state :
"As we have said previously, the slowdowns related to Sept . 11 impacted ourfourth quarter bookings, particularly our quick turnaround business ," Greer said."First quarter 2002 bookings to date appear to be returning to normal as dailyorder input patterns are starting to improve, which gives us confidence for our
2002 outlook. . . . "
Reasons Why False and/or Misleading :
271 . FY02 Targets Grossly Inflated: Defendant Greer's statement regarding confidenc e
in the 2002 outlook because "[f]irst quarter 2002 bookings to date appear to be returning to normal"
was false and misleading because, according to CW2, defendant Greer did not disclose that the 2002
forecasts were highly inflated and unlikely to be met . As mentioned above, defendant Greer insisted
that all of Flowserve's divisions achieve a 15% growth in "top- line" sales, irrespective of business
conditions. To justify this forecast, managers were to assume all events necessary to warrant a 15%
growth forecast would happen . These overly optimistic assumptions were made despite the
managers' knowledge that the actual sales reports made such a growth forecast unlikely . For 2002,
the forecasts were made before the events of 9/11/01 . This meant that the 2002 targets did not
account for the decline in business caused by this event and were never revised . The 2002 targets,
therefore, not only were based on a 15% inflated growth target but also ignored the decline in
business already being realized . Defendant Greer's statement, therefore, expressing confidence in
the 2002 outlook and suggesting that "[f]irst quarter 2002 bookings to date appear to be returning to
normal" was misleading because they did not disclose that Flowserw's 2002 outlook was grossly
inflated.
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272 . Defendants Greer and Hornbaker Control Finance Department : According to
CW28, the overall tone of defendant Greer 's meetings , particularly with Giddings and Hornbaker,
was to devise a script designed to please analysts and public investors, rather than convey the truth
of the Company's condition . According to CW28, Greer was especially volatile in preparation for
calls with the public, and various individuals from the finance department were called into meetings
and sent out with various directives from Greer . These finance employees seemed "afraid" and
appeared "uncomfortable" with directives as they left the conference room. Although there wer e
often heated discussions between defendants Greer and Hornbaker, CW28 blt that defendant
Hornbaker and the controller, Giddings, were generally complicit in assisting defendant Greer to
create scenarios that were not based on actuals generated by the finance department .
273 . False Statement : The 2/4/02 press release also contained comments from Greer
regarding "significant sales synergies" from the acquisition :
"Since we acquired IDP, we have primarily talked about the hard synergiesand the reduction of costs achieved by integrating the two companies," Greer said ."Entering the integration process, we also recognized that there were significantsales synergies . We are extremely bullish on the range of products we now possess-a range that no other company can provide . This should lead us to capture moreincremental sales and increased market share ."
Reasons Why False and/or Misleading :
274 . Unprofitable Move to Distributors : Defendant Greer's statements regarding the
"significant sales synergies" realized by the integration process and the likelihood that the ID P
acquisition would bad to "more incremental sales and increased market share" were misleading
because, according to CW4 and CW5, defendant Greer did not disclose that a part of the "significant
sales synergies" involved laying off sales staff and moving towards less knowledgeable distributors .
As a part of these sales synergies, Flowserve moved to making about 85% of its pump sales through
distributors and about 15% through direct salespeople . Flowserve's reliance on distributors
increased at the expense of sales . Compared to the direct sales staff, distributors were less familiar
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with the customers and had less focused expertise because they sold the products of many
companies . Thus, defendant Greer's statements regarding the realized sales synergies were
misleading because they did not disclose that moving pump sales to a centralized general, but less
qualified, sales staff to reduce certain cost outlays resulted in customer dissatisfaction that cos t
Flowserve business and a decrease in sales .
275 . Distributors Steal Business : The IOb-5 Defendants knew margins were decreasing .
Thus, to help offset the effect of the decreasing margins, Flowserve cut cost of sales expenses .
According to CW7 and CW9, Greer had decided to eliminate the Durco sales distributors in
territories that overlapped with IDP distributors at the end of 2000 . This decision led to fierce
competitive retaliation by the Durco distributors, who capitalized on their close relationships with
the Durco pump customers . The distributors kept their customers by setting up replicator businesses,
using reverse engineering to produce the products necessary to compete with and take the business
away from Flowserve . The effects of defendant Greer's decision and Flowserve's loss of a
substantial amount of the very profitable spare parts business were also discussed .
276 . False Statement : Defendant Greer also stated in the 2/4/02 press release that the IDP
integration captured synergies from the acquisition :
"Looking back at 2001, we said it would be a year of integrating IDP andcapturing the synergiesfrom that acquisition ," Greer said . "As we enter 2002, we
maintain our optimistic and upbeat outlook . Many of our key end- markets are poised
for positive growth. In petroleum, upstream and downstream spending shouldremain at good levels, spurred by the ongoing quest to replace depleting wells and by
mandated environmental requirements . "
Reasons Why False and/or Misleading :
277 . Operations Difficulties Hid as Integration Expenses : Defendant Greer's statement s
in the 2/4/02 press release regarding "capturing the synergies from [the IDP] acquisition" were fals e
and misleading because, according to CW1, they failed to disclose that the "savings" from the
integration were inflated to conceal other problems that existed within the Company's plants. For
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example, one of Flowserve's plants in Newark, was experiencing substantial losses unrelated to th e
IDP integration . The costs of closing portions of this plant, including closing the foundry and out-
sourcing the machining, which were losing money for other reasons, were integrated into th e
synergy savings even though they had nothing to do with the integration of IDP itself . The sam e
occurred with the downsizing of a plant in Vernon that was experiencing low demand in the nuclear
sector. Rather than disclose that these plants would not meet their forecasts, Flowserve integrate d
the downsizing and closing of these plants into the "savings" associated with the IDP acquisition .
278 . False Statement : The 2/4/02 press release also published Flowserve's net income for
2001 :
Net income before special and extraordinary items in 2001 was $55 .8 million, or$1 .42 a share, an increase of 5 percent compared with net income of $51 .0 million, or$1 .35 a share, in 2000 calculated on the same basis . The results for 2001 are anincrease of 407 percent compared with pro forma net income of $10 .7 million, or 28
cents a share, in the prior year calculated on the same basis .
279 . False Statement : The 2/4/02 press release also published Flowserve's condense d
consolidated financial statements for the year ending 12/31/01 .
280 . As Admitted in Restatement : As admitted by the 10b-5 Defendants in thei r
Restatement, and as explained in ¶¶129-179, the financial results reported for the year ending
12/31/01 were materially false and misleading and were not reported in accordance with GAAP an d
SEC Regulation S-X (17 C .F.R. 210.4-01(a)(1)) . This statement was false and misleading when
made, because as admitted in the Restatement, Flowserve's net loss for the year 2001 wa s
understated by 600.6%.
11 . False and Misleading Statements Concerning the Completionof the IDP Integratio n
281 . False Statement : Defendant Greer confirmed the Company's 12/31/01 year end
financial results in the 2/5/02 conference call with investors and analysts :
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This morning we announce 4th quarter net income excluding special andextraordinary items of $0 .58 a share, a 16% increase compared with last year's 4thquarter calculated on the same basis and in line with our previous guidance . Fullyear 2001 net income excluding special and extraordinary items was a $1 .42, an
increase of 5% compared with last year's reported results and calculated on the samebasis .
282. As Admitted in Restatement : As detailed in ¶¶129-179, and acknowledged by the
IOb-5 Defendants in their Restatement, the financial results reported in the Form 10-K for the yea r
ending 12/31/01 were materially false and misleading and were not reported in accordance wit h
GAAP and SEC Regulation S-X (17 C .F .R. 210.4-01(a)(1)) . This statement was false and
misleading when made, because as admitted in the Restatement, Flowserve's net loss for the yea r
2001 was understated by 600 .6%.
283 . False Statement : Defendant Greer reiterated in a 2/5/02 conference call that the
integration of IDP and any dis-synergies related to the acquisition were well behind Flowserve :
Looking back at 2001 and how far we've come, it's been quite a year ofaccomplishment. First andforemost, we've completed the integration of IDP. In
fact, this is the last quarter we'll be talking about this topic . Despite disruptionscaused by the integration, we were able to maintain sales and bookings andpermanently reduce our cost structure . We entered 2002 leaner, with a higherbacklog and an improvedfinancial condition .
While for what will be the final time, I'll say a few words about the status of the IDPintegration. I'm pleased to say that the final integration issues have been resolvedand are now behind us . In fact the two most effective plants achieved recordshipments in the 4th quarter and those old l ow margin backlog is pretty much outthe door. With the integration behind us and the new pump division managementin place, we can now concentrate on growing this part of our business .
Reasons Why False and/or Misleading :
284 . Contingency Plans Developed Defendant Greer's statements on 2/5/02 regardin g
' .record shipments in the 4th quarter" from the "two most effective plants" were misleading whe n
made because according to CW7, defendant Greer did not reveal the internal problems threatenin g
the pump division . By late January 2002, Flowserve knew that bookings in the pump division fo r
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the last quarter of 2001 were the lowest they had been for the past two years . Because of these
internal problems, Flowserve was developing contingency plans that called for a reduction in their
employee headcount by either 5% or the more drastic 20% to avoid reducing their forecasts and
impacting their net income. Defendant Greer's 2/5/02 statements were misleading because, while
discussing the "record shipments in the 4th quarter," they did not disclose the low bookings in the
pump division that were threatening the division's revenue .
12. The lOb-5 Defendants ' False and Misleading StatementsConcerning the Year Ending 12/31/01 Financial Statement s
285 . False Statement : On 3/12/02, the lOb-5 Defendants filed their Report on Form 10- K
for the year ending 12/31/01 with the SEC, including the consolidated financial statements .
Defendants Greer and Hombaker signed the Form 10-K .
286 . As Admitted in Restatement : As acknowledged by the 1Ob-5 Defendants o n
4/27/04, the financial results reported in the Form 10-K for the year ending 12/31/01 were materially
false and misleading and were not reported in accordance with GAAP and SEC Regulation S -X (17
C.F .R. 210.4-01(a)(1)) . The following chart summarizes the restatement ( in millions, except per
share data) :
2001
Net Earnings
EPS (basic)
EPS (diluted)
TotalAs Inventory & Restatement
Previously Cost of Sales Other Adjustments Tax As
Reported Adjustments Adjustments (pretax) Adjustments Restate d
(1 .5) (10.8) (0.9) (11 .7) 2.7 (10.5)
(0.04) (0 .23) (0.27)
(0.04) (0.23) (0 .27 )
287 . As Admitted in Restatement : As described in ¶¶129-179, the lOb-5 Defendant s
knew that: (i) the financial results originally issued during the Class period for the Sear ending
12/31/01 and the public statements regarding those results were false and misleading and (ii) th e
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financial statements reported for the year ending 12/31/01 were incorrect based on information
available to the lOb-5 Defendants at the time the results were originally reported .
288 . False Statement : The Report on Form 10-K for the year ending 2001 provided ,
among other things, that "[a]t December 31, 2001, the Company was in compliance with thes e
covenants ."
289 . In Violation of Loan Covenants : As detailed in ¶¶129-179, and acknowledged by
the l Ob-5 Defendants in their Restatement, these statements regarding Flowserve's compliance with
their loan covenants were materially false and misleading at the time it was made . Due to the
Restatement, on 12/31/01, the Company would not have been in compliance with their loa n
covenants .
13. The lOb-5 Defendants ' False and Misleading StatementsConcerning the 2001 Annual Report
290 . False Statement : On or about 3/19/02, Flowserve disseminated its 2001 Annual
Report to its shareholders . The Annual Report confirmed the previously announced financial result s
for the year ended 12/31/01 .
291 . As Admitted in Restatement : As detailed in ¶¶129-179, and acknowledged by th e
10b-5 Defendants in their Restatement , the 12/31/01 Form 10-K and associated financial statement s
were materially false and misleading at the time they were made . The false statements in the
12/31/01 Form 10-K were also false and misleading at the time Flowserve issued the 2001 Annua l
Report .
292 . False Statement : The 2001 Annual Report provided, among other things, that "[a] t
December 31, 2001, the Company was in compliance with these covenants . "
293 . In Violation of Loan Covenants : As detailed in ¶¶129-179, and acknowledged by
the l Ob-5 Defendants in their Restatement, these statements regarding Flowserve's compliance wit h
their loan covenants were materially false and misleading at the time it was made . Due to the
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Restatement, on 12/31/01, the Company would not have been in compliance with their loan
covenants .
294 . False Statement : Also in the 2001 Annual Report, the lOb-5 Defendants made th e
following representations concerning the Company's operations and financial outlook :
In August 2000, we completed our purchase of the Ingersoll- Dresser PumpCo. and began the work of capturing real synergy savings . In 2001, we committedourselves to achieving a $75 million annual run rate in savings by year-end .
2001 : A YEAR OF INTEGRATION SYNERGIES AND BALANCE SHEETIMPROVEMEN T
As we closed 2001, synergy savings stood at a run rate ofmore than $90million . As a result of the captured synergy savings, our operating margin, beforerestructuring and integration expenses, is now 10 .6 percent, up more than three fullpercentage points from when we began our integration efforts in 2000 . Clearly, theacquisition of IDP has produced the significant benefits that we expected .
We discontinued significant redundant operations as part of the IDP
integration - closing IDP headquarters, a number of manufacturing and repairfacilities and reducing our sales and marketing staff . Integrating two companies, twocultures, is never easy and we encountered a number of hurdles during 2001 . Insome instances, we did not deliver product on time and our customer service fell . Inresponse, we focused on fixing the fundamentals - purchasing, scheduling and otherbasic processes - and we introduced the Flowserve Management System to align ouremployees' individual objectives with our operating plans . As we enter 2002, I'mconfident we've resolved the majority of our integration issues .
When we acquired IDP, we also promised to reduce our financial leverage tomarket levels as quickly as possible . In late 2001, we successfully issued 6.9 millionshares of common stock with minimal dilution and used the proceeds to strengthenour balance sheet by retiring approximately $133 million of high-cost debt . Ourdebt-to-capital ratio declined to 71 percent at year-end . We expect to makeadditional debt reduction in 2002 .
Reasons Why False and/or Misleading :
295 . Pump Division Lowers Fo recast : Defendant Greer's statements in the 2001 Annua l
Report that "[a]s [Flowserve] enter[s] 2002, I'm confident we've resolved the majo rity of our
integration issues" and "[c]learly the acquisition of IDP has produced the significant benefits that w e
expected" were false and misleading because, on 2/20/02, defendants Greer and Hornbaker receive d
the Weekly Repo rt from the pump division stating that for bookings , "While EMA [ the European
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division] is holding their forecast at $12.6M or 7% below Plan for tine month, Americas has again
lowered their forecast by another $2M and currently are $11 .3M versus a Plan of $15 .1M." The
weekly report listed some possible actions, but concluded that "Unfortunately, it is not expected that
these actions will favorably impact the current quarter, but, it is believed that they we [sic] will see
positive results starting in Q2 ."
296 . Reduction in Shipments and Cash Flow a Problem On 2/27/02, defendants Greer
and Hornbaker received the Weekly Report from the pump division stating that "Overall [fo r
bookings], the Engineered businesses continue to maintain some consistency while the Industria l
side is weak. The Industrial businesses lowered their outlooks by $1 .2M or 7% from the prior week .
Specifically, Newark and Chesapeake are the weakest, with Chesapeake projected to be off as much
as 25% for the month ." The Report went onto state that for shipments, "There has been a significant
reduction in shipments over the prior week driven by Engineered Americas ($5 .9M)." Under "Other
Items," the Report warned, "Attention to cash flow continues to be a priority item . "
297 . Contingency Plan Developed On 2/27/02, a vice president in the pump division ,
Rene Blanchais, sent an e-mail to several employees in the pump division warning that "We have a
serious concern on bookings related to Newark operation." According to the e-mail, "the last quarter
2001 was not good at all, [and] the first 2 months are also low at 50% of plan level on completes ."
Accordingly the Vice President asked the pump division to prepare an "intelligent" contingenc y
plan, based on estimates for the year 2002, and that "[w]e [Corporate] will base our headcoun t
reduction on these [sic] updated data . "
298 . Contingency Plan Enacted : A 3/5/02 e-mail from a vice president of the pump
division, Rene Blanchais, stated "At this stage of the year 2002 and based on last year [sic ]
unfortunate experience on results, it is mandatory to implement a contingency plan right now . "
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299 . Low Cash Flow. CW7 received an internal Flowserve memorandum urging the
division managers to try to find ways to move their receivables because the cash flow for February
was so low that the Company was "in danger of failing the bank covenants at 31 March 02 ." Thus,
Flowserve's balance sheet was not strong, as it promised in its Annual Report . In fact, the
memorandum also stated that the Controller was evaluating factoring in the end of March and
postponing major payments until April . According to CW7, the information contained in this e-mail
originated with defendants Greer and Hornbaker .
300 . Unrelated Departures Counted As Integration Expense : Statements made by
Greer in the 2001 Annual Report were misleading, as the Annual Report stated that final synergy
savings for 2001 stood at $90 million. Although a $75 million run rate savings was used during
2001, it was increased to $90 million in the 2001 Annual Report . This was misleading because,
according to CW6, during the first eight months of 2000, while the closing of the IDP acquisition
was delayed, a substantial number of employees left Flowserve and, despite these departures being
unrelated to the acquisition, they were still included in the synergy savings resulting from the
acquisition. Thus, Greer's statements that as Flowserve "closed 2001, synergy savings stood atar ul
rate of more than $90 million" were misleading because they counted unrelated employee departure s
for the purpose of meeting the synergy target metric .
301 . Dis-synergies Continue : Greer's statements in the 2001 Annual Report that "[a] s
[Flowserve] enter[s] 2002, I'm confident we've resolved the majority of our integration issues" and
"[c]learly, the acquisition of IDP has produced the significant benefits that we expected" were false
and misleading because, according to CW7, the disruption due to the integration was still continuing .
Defendant Greer's statement that the "majority of [Flowserve's] integration issues" were resolved
did not disclose the ongoing disruption from the integration (i .e ., poor quality product and inability
to timely deliver) and the dramatic impact it was having on bookings and revenue . The statement s
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concerning Greer's confidence that the majority of integration issues had been resolved were false
and misleading because, according to CW5, part of the IDP integration included a further aspect o f
centralization : processing all parts orders by the main parts distribution center in Moosic ,
Pennsylvania , which was formerly an IDP facility . The centralization caused delays in the shipmen t
of orders, and large customers, such as DuPont, which could obtain a part in one day under the pre-
IDP decentralized system, moved to other suppliers rather than continuing to rely on Flowserve's
inferior post-integration service. Greer's statements regarding "discontinu[ing] significant redundant
operations" and "resolv[ing] the majority of integration issues" were misleading because the
integration and centralization of IDP and Flowserve facilities led to delays in shipment of parts an d
caused Flowserve to lose important customers (i .e., DuPont) .
302 . Management Turnover. Another major factor in the poor performance of several o f
Flowserve's plants was the high rate of management turnover . Flowserve faced high- leve l
defections at not only the plant management level, but also at key positions such as procuremen t
managers and production managers , according to CW6. But Flowserve' s management problems
went deeper than just high turnover . As a part of the acquisition of IDP, Flowserve formed the IMT
to assist in the integration of IDP. Although the I Ob-5 Defendants represented to the public that th e
integration had gone smoothly, actual results belied this claim . Insisting that the IMT had missed its
numbers, Flowserve did not pay bonuses due to its integration managers . The IMT filed a lawsui t
against the company . As a result of this lawsuit, defendant Greer asked for the resignations o f
approximately 22 Flowserve executives who were a part of this lawsuit . According to CW7, the
departures ranged from the head of European operations down to the plant management level . The
impact of losing such high- level managers was broad and widely felt, yet it was never fully disclose d
to the public . In addition, the savings from Flowserve's failure to pay bonuses due were accounted
for as synergies .
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303 . Greer Was Rewarded for His Fraud : In addition to his $663,000 salary, defendan t
Greer was paid $56,000, for items such as a financial planner and country club membership, an d
reaped an additional incentive based bonus of over $186,000 for his role in Flowserve's performance
- for total compensation of over $907,000 in 2001 .
304 . Hornbaker Was Rewarded for Her Fraud : In addition to her $296,000 salary ,
defendant Hombaker reaped an additional incentive based bonus of over $62,000 for her role i n
Flowserve's performance - for total compensation of over $365,000 in 2001 .
14. The lOb-5 Defendants ' False and Misleading StatementsConcerning the April Prospectus Supplement.
305 . False Statement : The April Prospectus Supplement made effective on or about
4/18/02 described the Company's intended use of the proceeds of the April Offering as follows :
The net proceeds to us from the sale of common stock in this offering are estimatedto be $239 .7 million, or $275 .8 million if the underwriters' over-allotment option isexercised in full, after deducting underwriting discounts and commissions andestimated offering expenses payable by us . We intend to use the net proceeds fromthis offering, together with additional borrowings under our amended senior creditfacilities, to finance the IFC Acquisition, to refinance our existing tranche B termloan facility, to repay a portion of the outstanding indebtedness under our existingsenior credit facilities and to pay transaction costs and expenses . . . .
306 . False Statement : The April Prospectus Supplement, provided, among other things ,
that "[a]t December 31, 2001, we [the Company] were in compliance with these covenants ."
307 . False Statement : The April Prospectus Statement stated :
RELATIONSHIP WITH AFFILIATES OF CERTAIN UNDERWRITER S
We are in compliance with the terms of the indebtedness owed by us toaffiliates of Credit SuissefirstBoston Corporation and Banc ofAmerica SecuritiesLLC. The decision of Credit Suisse First Boston Corporation and Bane of AmericaSecurities LLC to distribute our shares of common stock was not influenced by theirrespective affiliates that are our lenders and those affiliates had no involvement indetermining whether or when to distribute our shares of common stock under thisoffering or the terms of this offering . . . . we intend to use [a portion of] the netproceeds from this offering to repay indebtedness owed by us to affiliates of CreditSuisse First Boston Corporation and Banc of America Securities LLC .
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308 . In Violation of Loan Covenants : As detailed in ¶¶129-179, and acknowledged by
Flowserve in its Restatement, these statements regarding Flowserve's compliance with their loa n
covenants were materially false and misleading at the time it was made . Due to the restatement, on
12/31/01, the Company would not have been in compliance with its loan covenants .
309 . False Statement : The April Prospectus Supplement also incorporated by referenc e
Flowserve's Annual Report on Form 10-K for the year ended 12/31/00 .
310 . As Admitted in Restatement : As detailed in ¶¶129-179, and acknowledged by the
l Ob-5 Defendants in their Restatement, the 12/31/00 Form 10-K and associated financial statement s
were materially false and misleading at the time they were made . The false statements in th e
12/31/00 Form 10-K were also false and misleading at the time Flowserve issued the Apri l
Prospectus Supplement .
311 . Conflict of Interest: In connection with Flowserve's April offering, BofA was paid
$2 .23 million and CSFB was paid $3 .44 million in underwriter fees by Flowserve . The April
Prospectus Supplement disclosed the following about BofA and CSFB's affiliations :
Certain of the underwriters and their respective affiliates have from time to time
performed and may in the future perform various financial advisory, commercialbanking and investment banking services for us, for which they received or will
receive customary fees. Specifically, affiliates of Credit Suisse First BostonCorporation and Bank of America Securities LLC are lenders under our existingsenior credit facilities and have received customary banking fees in that capacity . In
addition, affiliates of Credit Suisse First Boston Corporation, Merrill Lynch, Pierce,Fenner & Smith Incorporated, Banc of America Securities LLC and Bear, Stearns &Co . Inc. have provided commitments under the Incremental Tranche A Term Loanand the Incremental Tranche C Term Loan in connection with the IFC Acquisitionand have received customary banking fees in that capacity .
312 . False Statement : The April Prospectus Supplement included the Company' s
previously announced "improved" first quarter 2002 earnings and presented historical and pro form a
consolidated financial information for the Company . The pro forma financial information wa s
presented for the year ended 12/31/01 and gave effect to the IFC acquisition, the financing of th e
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acquisition and certain other debt reductions, as if each had occurred as of 1/1/01 . As a result,
Flowserve's pro forma 2001 EBITDA was increased by 34% over the Company's actual reporte d
results during that year .
313 . False Statement : The April Prospectus Supplement provided, among other things ,
the following representations concerning the pending acquisition of IFC :
We expect to realize a number of significant strategic and competitivebenefits as a result of the IFC Acquisition, including the following:
- Expanded Geographic and Market Opportunities . We expect the IFCAcquisition to provide us with opportunities to expand both our geographic andindustry reach. IFC's significant global presence, particularly in Europe, willenhance our ability to capitalize on the trend among global customers towardconsolidated sourcing of their flow control products . The IFCAcquisition will alsomake us the second largest manufacturer of valves in the world and provide uswith a more balanced revenue mix by strengthening our presence in valve productsin the petroleum , power, water resources, pharmaceutical and general industrymarkets. In addition, as IFC's historical focus has been more on valve products thanon service, the IFC Acquisition will provide us with an opportunity to service thesignificant portion of IFC's installed base of valves whose service needs are currentlybeing provided by third parties .
Reasons Why False and/or Misleading :
314 . IFC Acquisition a "Bad Deal" : CW2 warned Greer about the unsuitability of th e
IFC acquisition . CW2 was among several valve division executives who advised the head of th e
valve division and defendant Greer that the proposed acquisition of IFC was a "bad deal" becaus e
IFC's numbers were "bad." CW2 characterized the IFC deal as a "pig in a poke." CW2 said that
defendant Greer ignored these warnings and proceeded with the deal .
315 . IFC Predicting Low Sales : According to CW18, his/her sales group within IFC was
"predicting bad sales numbers until 2004 . "
316 . Hornbaker 's Insider Sales : Defendant Hornbaker sold her shares in violation of the
explicit terms of the April Prospectus Supplement, which precluded officers and directors fro m
selling their shares of Flowserve stock within 90 days of the 4/16/02 effective date . Within two
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weeks, defendant Hornbaker sold 50,000 shares of her Flowserve stock between the dates of 4/25/02
and 4/30/02 . She sold her shares at prices ranging from $33 .045 to $34.1022 per share and realized
$1,689,576 in proceeds .
317. During April 2002, the Company completed the April Offering realizing over $289 .9
million in net proceeds .
15. The lOb-5 Defendants' False and Misleading StatementsConcerning 1Q02 Results
318 . False Statement : On 4/22/02, the Company issued a press release announcing its
financial results for the quarter ended 3/31/02 :
First quarter 2002 net income was $12 .7 million, or 28 cents a share, an increase of180 percent compared with the prior year quarter, before integration expenses . Firstquarter 2001 net income was $3 .7 million, or 10 cents a share, before integration
expenses . Including integration expenses, the company reported a net loss of $8 .5million, or 22 cents a share, in the first quarter of 2001 .
319 . False Statement : The 4/22/02 press release also included Flowserve's condense d
consolidated income statement for IQ02 .
320 . As Admitted in Restatement : These statements referenced in ¶¶318-319 were fals e
and misleading when made, because as admitted in the Restatement, Flowserve's net income for the
first quarter of 2002 was inflated by 29 .4% .
321 . False Statement : In the 4/22/02 press release, defendant Greer commented on th e
strength of bookings seen by Flowserve :
"Flowserve posted solid results in the first quarter of 2002," said Chairman,President and Chief Executive Officer C . Scott Greer. "I am pleased with our growth
in earnings despite relatively flat sales . I am also gratified by how these resultsconfirm that we have put the IDP integration costs behind us and that we arerealizing the IDP synergy benefits . Moreover, I am encouraged by the sequentialquarterly increase in bookings. This increase in bookings supports our view thatactivity in some ofour key markets is improvingfollowing the slowdown related toSept.11. With this as a backdrop, and following our successful equity offering, weare eager to complete our pending acquisition of Invensys plc's Flow ControlDivision (IFC) in early May and take advantage of the many benefits it shouldprovide our customers and shareholders . "
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Reasons Why False and/or Misleading :
322 . Slowdown in Valves : According to CW2, by mid-2002, Flowserve's valve divisio n
was facing a significant slowing of demand, which was particularly noticeable with respect to th e
valve products used in the power industry, where production lead times are lengthy . According to
CW2, both backlog and bookings were falling .
323 . IFC in Chaos : According to CW18, after the acquisition , the former IFC valve
companies entered a state of confusion . Employees did not know from day to day whether the y
would keep their jobs . The President and Vice President of Sales were fired, while bookings
continued to fall significantly .
324 . IFC Dis-synergies : According to CW3, the IFC integration experienced its own dis-
synergies . Reorganization of the valve facilities of IFC forced steep and delay-producing learning
curves on management and employees . These complications took on an added importance, as the y
took place at a time when slumping demand for Flowserve's products required attention t o
customers. In addition, physical relocation of equipment produced delays, as did the physica l
relocation of inventory, which thereby became unavailable for timely delivery to customers .
325 . Decline in Business : CW 19 independently confirmed the difficulties faced after the
IFC acquisition. According to CW19, as a part of the integration process, Flowserve consolidate d
operations and closed certain facilities . Closure of plants that manufactured more custom-mad e
items caused some customers to shift to non-Flowserve brands, resulting in a decline in the total
amount of business done by Flowserve plants as "customers went elsewhere, to competitors ." For
example, in 2001, manufacturing operations from a plant in Cincinnati, Ohio had been relocated t o
the Provo , Utah facility, and then , in 2002, about 18 months later Flowserve closed the Provo plant .
326 . Loss of Customers : This pattern of plant closures and confusion was confirme d
independently by CW4, who explained that IFC was a "troubled company" when Flowserve bough t
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it, and then Flowserve used its management and sent Flowserve's existing management ontheir way .
In shifting the valve production from one facility to another, the effort to centralize and
consolidate/shrink plants and personnel also produced negative results . According to CW4, one
example included when the production of the Valtek brand- name valves for the European market
were shift from the plant in Pershore, United Kingdom to a former Invatec facility . After this shift,
Dow Chemical stopped buying certain valves from Flowserve because the products could not be
serviced adequately after the plant was moved. Relocation of the plant resulted in the loss o f
employees with the requisite expertise.
327 . Decline in Sales : According to CW8, immediately prior to the Flowserve acquisition ,
the head of IFC had announced a strategy of cutting the sales force and replacing staff with outside
distributors . As a result of this change, sales began to decline, and the decline was particularly felt i n
higher margin products, such as custom- made valves .
L. The lOb-5 Defendants ' Scheme Begins to Unravel
328 . False Statement : On 7/22/02, after the close of the market, Flowserve issued a pres s
release announcing its financial results for the second qua rter and six months ended 6/30/02 . The
press release stated in relevant part as follows :
Excluding special items, net income was 46 cents a share in the second quarter of2002, an increase of 31 percent compared with the prior year period, and within therange of the company's previously announced estimates .
329 . False Statement : The 7/23/02 press release also included Flowserve's condense d
consolidated financial statements for 2Q02 .
330 . As Admitted in Restatement : The statements referenced in ¶¶328-329 were false
and misleading when made, because as admitted in the Restatement, Flowserve's net income for the
six months ended 6/30/02 was inflated by 11 .8% and net income for the year 2002 was inflated by
14.2% .
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331 . False Statement : The 7/22/02 press release also discussed Flowserve's lowered
estimates for 3Q02 and full year 2002 :
"Of particular concern is the deterioration of the quick-ship business in the chemicaland industrial sectors . At the beginning of the year, we had expected this business to
be flat to slightly down for the year. During the second quarter, bookings for this
sector experienced double-digit year-over-year declines . Considering the importanceof this business to our margins, this type of volume decline coupled with our planned
inventory reductions will make profit improvement difficult .
"While there has been an increase in the level of inquiries, we don't foresee much in
the way of real spending increases until 2003 . As a result of the decline in chemicaland industrial bookings in the second quarter coupled with the resulting drop inbacklog, it is only prudent to estimate earnings per share, excluding special items,in the range of 38 to 43 cents in the third quarter of 2002 and $1 .70 to $1.90 for
the full year," Greer said.
Separately, the company said it has realigned its operating segments beginningwith the third quarter of 2002. Under this new organization, the Flow SolutionsDivision will include Seals only, with the company's pump and valve service
businesses being included as appropriate in the Flowserve Pump Division andFlow Control Division .
332 . False Statement : On 7/23/02, the Company held an earnings conference call wit h
market analysts, attended by defendants Greer and Hornbaker, among others . Defendant Gree r
commented on Flowserve's "bookings" - a key indicator of the Company's future sales trends -
stating, in pertinent part, as follows :
Given the worse than expected booking climate in the chemical andindustrial area, we expect third quarter earnings to be in the range of 38 to 43cents per shares with the full year at 170 to 190 excluding any special itemsassociated with the IFC acquisition.
333 . False Statement : Analysts questioned defendant Greer regarding the stark contras t
between the Company's second quarter operating results and the "roadshow" presentations mad e
earlier during the quarter promoting the Company's stock offering:
MICHAEL SCHNEIDER, ROBERT W . BAIRD: Robert W. Baird . Maybeyou could give us a sense, just first looking through the quarter? You mentioned thatyou saw some up tick in the general industrial and the chemical business in March,Scott, but, did it precipitously fall off as you went through the quarter? Because youwere on the road in April for the road show, you discussed IFC in May, it just seemsto me something happened late in the quarter that came as a surprise .
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SCOTT GREER: Yeah, normally, when you look at how our quarterbookings are, usually they are stronger at the end of the quarter than the beginning of
the quarter . The salesmen are trying to make sure they book things as they originallyprojected it. So what we saw is it was getting back in line from a more normal downmarket at the very end of the first quarter . Whatwe saw is a continued decline andactually not foreseen by our salespeople. They actually thought, talking to thecustomer, that they were going to bring in some more quick turnaround Andremember, that is a major part of every quarter. It's not just in our backlog and itdidn 't come through .
Then checking with what all of our competitors are saying, it seems to be thesame type of sluggishness there. So what we're looking at going forward, well, youknow, we were able to handle in Q2, our concern if it continues at this lower rate into
Q3 and on, is really why we're taking a more conservative outlook.
Again, what I do want to stress, you know, if we're being overly
conservative, you know, we'll move the guidance back up .
RENEE HORNBAKER : Mike, all of our internalforecasts were for sales tobe up in June and they just weren 't and they just weren 't and they just didn'tmaterialize -
SCOTT GREER : Bookings you mean?
RENEE HORNBAKER : Bookings, I'm sorry, bookings, just didn'tmaterialize as we expected them to do .
Reasons Why False and/or Misleading :
334 . Missed Monthly Targets : According to CW10, although management raised
shipment targets substantially at the Chesapeake plant following the Durco transfer, the plant could
not meet these numbers . Shipments continued to decline because of orders shipped late, incorrectly
manufactured product and dissatisfied customers . In November 2001, the Chesapeake monthly
target was about $15 million, with actual sales being around $12 million per month . This target
continued to rise, reaching a top of about $17-$18 million in June or July 2002 . At this time, the
actual monthly shipment was only around $4 million.
335 . Shipping Incomplete Pumps : According to CW10 and CWI1, the Chesapeake
facility made its monthly shipment quota only once during 2002 . On numerous occasions during
2001 and 2002, particularly at the end of the month and end of the quarter, the facility shipped out
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anything they could, including incomplete pumps, in attempt to meet quota . Shipments were late by
anywhere from two to four months . As a result, customers were lost and orders were cancelled
because of both poor quality pumps and the late shipments .
336 . Invoicing Prior to Shipment : According to CW10, during the January-August2002
timeframe, the Chesapeake plant also invoiced products before they were shipped, in order to make
the monthly shipment targets. One such incident occurred in the spring/summer of 2002, where a
customer had placed an order totaling at least $10 million . Shipping spreadsheets showed
approximately half of this order as invoiced and shipped to the customer, although the order was not
actually shipped until the next month .
337 . Increased Costs and Delays : According to CW26, as a part of the IDP acquisition ,
the IDP plant at Gateshead, England was closed and 75% of the work transferred to Etten-Leur . As
a result, Etten-Leur experienced a 250% increase in production demands, from $35 million to $80
million, during the approximate two-year (+) period starting in 2001 and ending in 2003 . EttenLeur
lost its standard procedures, because in addition to the pressures of rapid growth, the new work
transferred was a different product line of very large pumps that were difficult to build . Etten-Leur
could not maintain its production schedule, costs increased and delivery suffered great delays . Prior
to closing, the Gateshead plant employed 300 employees, but only 65 new jobs were allocated t o
Etten-Leur with the transfer of the work .
338 . Plants Miss Plan: According to CW26, Etten-Leur significantly missed its plan ever y
year from 2001 through 2003 . Each monthly and quarterly report showed that. The basic message
in each report was "we're not making Plan and here 's why." According to CW26, defendant Gree r
had current knowledge of all of this information .
339 . WIP Still Out-of-Control : Greer's statements about bookings were false and
misleading because he was still not disclosing the entire extent of difficulties left-over from the IDP
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acquisition. According to CW33, "after the fact" - meaning after the IDP acquisition was completed
by sometime in about 2002 - CW33 learned through various sources that the WIP inventor y
accounting for both the Vernon plant and Etten Leur was "out of control ." Essentially, Flowserve
made the decision to "just pretend the problem didn't exist" in its financial reporting.
340 . SLOB Inventory : CW33 explained that "tax guys" have an interest in variance with
the "accounting guys" over inventory, especially that which may be considered obsolete . In the
category known as "SLOB" inventory, the proclivity of tax accountants is to write these balances
off, whereas the finance accountants look for ways to create reserves . According to CW33,
Hornbaker was "very sensitive" to any increase in reserves . She was concerned that if obsolete
inventory were written off, the company's public accountants might question whether there wa s
more of this problem than was visible and direct the company to increase reserves . As a result ,
Hornbaker "pushed back" on CW33's attempt to quantify a write-off of SLOB, instead looking t o
increase reserves rather than put Flowserve in a position where the public accountants would decid e
the level the reserves should be at . In addition, some of the inventory that was likely SLOB, at leas t
in CW33 's opinion, based on the age of the inventory, was kept on the books as good inventory . As
an example, CW33 said the Flowserve plant in Rosendahl, Holland was carrying inventory as goo d
on the books for three to five years - much of it made initially for special orders - which, for one
reason or another, did not get produced .
341 . Obsolete Specialty Parts : In other plants, CW33 saw examples of large castings -
very expensive and also specially made for particular orders that were never built - remaining on th e
books as good inventory where CW33 felt that clearly, these high-value items should have bee n
written off as obsolete . CW33 personally saw volumes of these large, unused castings against the
back walls of the Vernon plant during visits in 2002 and 2003 . CW33 said there was little to do with
these parts, if they were not used on the pumps for which they were originally built . CW33 state d
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that "you can't do much with them to turn them into something else ." In CW33's view, these type s
of materials should have been scrapped and written off as obsolete inventory . CW33 personally saw
these large configurations "covered with dust" against the back walls of other plants the witnes s
visited, including Etten Leur and the Holland facility sometime in 2002 .
342 . Greer's Personal Knowledge of Plant Inventory : Greer would have had personal
knowledge of Flowserve's large obsolete inventory, because he personally visited Flowserve' s
plants . According to CW33, Greer walked through the various Flowserve pump production plants
prior to each of the CEO's off- site personal meetings with plant management.
343. In reaction to Flowserve 's 7/22/02 and 7/23/02 announcement, the price of Flowserve
common stock fell over 37%, closing at $14.55 per share on 7/23/02 .
M. Greer and Hornbaker Sign Sarbanes-Oxley Certifications UnderOath
344 . False Statement . On 8/14/02, both Hornbaker and Greer filed statements under oat h
that :
No covered report contained an untrue statement of a material fact as of theend of the period covered by such report (or in the case of a report on Form8-K or definitive proxy materials, as of the date on which it was filed)
No covered report omitted to state a material fact necessary to make thestatement in the covered report, in light of the circumstances under whichthey were made, not misleading as of the end of the period covered by suchreport (or in the case of a report on Form 8-K or definitive proxy materials, asof the date on which it was filed)
345 . False Statement . This statement under oath included as a "covered report" :
2001 Annual Repo rt on Form 10-K of Flowserve
All reports on Form 10-Q, all reports on Form 8-K and all definitive proxymaterials of Flowserve Corporation filed with the SEC subsequent to thefiling of the Form 10-K identified above
Any amendments to any of the foregoing
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346 . As Admitted in the Restatement : The statements referenced in ¶¶344-345 were
false and misleading when made, because as admitted in the 4/27/04 restatement, Flowserve's net
income for the years 2000, 2001 and 2002 were inflated by 18 .3%, 600 .0% and 14.2%, respectively .
N. Flowserve Begins to Partially Reveal Previously Undisclosed Material
Information
347 . False Statement : On 9/27/02, the Company issued a press release announcing that i t
expected to report an earnings shortfall of $0.08 to $0 .11 per share for the third quarter ending
9/30/02 . Defendant Greer blamed market factors rather than the material adverse information
disclosed above for Flowserve's revenue shortfall . The press release stated in relevant part as
follows:
Citing market-related factors, [Flowserve] today lowered its 2002 earningsestimates to 30 to 32 cents for the third quarter and $1 .45 to $1 .55 for the full year,excluding special items, which relate to the May 2002 acquisition of the InvensysFlow Control Division (IFC) . The company's previous guidance had been 38 to 43
cents for the third quarter and $1 .70 to $1 .90 for the full year, on the same basis .
These market-relatedfactors include unanticipatedfurther deterioration of
typically higher margin book-and-ship, or quick turnaround, business , particularlyin the chemical, power, and general industrial sectors, and an unfavorable mix oflower margin project business.
348 . False Statement : Defendant Greer commented on the Company's future prospects :
"In some of our end-markets, particularly upstream petroleum and water,bookings have held up," Greer added. "Additionally, I remain optimistic about thecompany's prospects for 2003 and beyond . We are continuing to make importantprogress in strengthening the company's balance sheet and operational processes .
That said, we are not comfortable at this point projecting more than marginalearnings improvement in 2003, unless markets start to improve. And, we believethey will ."
349 . Market reaction to the Company's disclosures about the earnings shortfall was swif t
and severe as the price of Flowserve common stock fell over 38%, closing at $8 .70 per share on
9/27/02, a decline of more than 75% from the Class Period high of $34 .90 reached on 5/2/02 .
350 . Defendants Furnish Additional Information Regarding Loan Covenants : On
9/27/02, Flowserve issued a second press release entitled , "Flowserve To File 8-K In Accordance
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With Regulation FD." In this press release, confirming the importance of Flowserve's loan
covenants to both investors and the SEC, Flowserve disclosed :
During a conference call discussing its news release issued today, thecompany furnished additional explanatory information concerning its compliancewith its bank loan covenants and is filing a Form 8-K with the SEC confirming this
information.
While key elements of this information were already in the public domain, thecompany is filing the attached financial details to enable investors to betterunderstand the company's compliance status under the bank covenants .
The company also reiterated it is in compliance with all of its bank covenants.
In addition, the company further clarified that its optional debt prepayment of $70million that was discussed in today's earlier announcement will be applied inchronological order to installments of principal scheduled to be paid in the next 12months and then pro rata against the remaining scheduled installments of principalpayments . In effect, the company will have no mandatory principal payment due inthe fourth quarter of 2002 nor in the first half of 2003 . The company said, however,that it expects to make additional optional prepayments in 2003 over and above whatis required .
351 . Flowserve Reaffirms Earnings Guidance in Informal Conversation : On 11/21/02,
Flowserve issued a press release regarding a Regulation FD Disclosure, where the l Ob- 5 Defendants
disclosed that:
During a conversation this week with securities analysts, Flowserve Corporation
reaffirmed its full year 2002 estimated earnings per share, excluding special items, inthe range of $1 .45 to $1 .55, based on average outstanding shares of approximately
52.5 million. The company also reiterated that it is not comfortable at this pointprojecting more than marginal earnings improvement in 2003, unless markets start toimprove . The company went on to say that it believes its markets will improve .
352 . Greer was Again Rewarded for His Fraud : In addition to his $710,000 salary ,
defendant Greer reaped an additional incentive based bonus of over $227,000 for his role in
Flowserve's performance, for total compensation of over $940,000 in 2002 .
353 . Hornbaker was Again Rewarded for Her Fraud : In addition to her $317,00 0
salary, defendant Hombaker reaped an additional incentive based bonus of over $76,000 for her rol e
in Flowserve' s performance , for total compensation of over $401,000 in 2002 .
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0. Information Released Subsequent to the Class Period
354 . Announcement of Restatement : Subsequent to the Class Period, the Company
trickled information out, announcing on2/3/04 that it was undergoing an audit that preliminarily ha d
resulted in an $11 million restatement of earnings in the pump and valve divisions during 2000 ,
2001, 2002 and part of 2003 .
355 . During the Class Period, the lOb-5 Defendants made numerous false and misleading
statements that created inflated expectations amongst investors regarding Flowserve's future
prospects . Among the false and misleading statements made by the lOb-5 Defendants were the
Company's financial results for 2000, 2001, 2002 and first three quarters of 203 that later had to be
restated, lowering pretax earnings by $23 .6 million . A company's historical financial results are a
key piece of information relied on and considered by investors forecasting that company's future
financial performance, which, in turn, provides the basis for the value of the company and its stock
price .
356. Greer and Hornbaker also inflated investors' expectations regarding Flowserve' s
future prospects by concealing serious integration problems relating to prior acquisitions, and by
providing specific erroneous guidance as to the Company's future earnings . When the Company
failed to meet the inflated expectations created by the 10b-5 Defendants' false and misleading
statements, Flowserve's stock price plunged . For example, when Flowserve announced on 7/23/02
that its financial results for the 2Q02 were well below investors' expectations, its stock price
declined more than 37%. Similarly, on 9/27/02, when Flowserve reduced its earnings guidance fo r
2002, its stock price declined 38% .
357 . The lOb-5 Defendants' Knowledge of and Reasons Why the Restatement Was
Materially False and Misleading : Flowserve's 4/27/04 Form 10-K/A and Form 10-K, whic h
provided the restated financials, was materially false and misleading because it did not disclose t o
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the public the true reasons behind the restatement of Flowserve's inventory amounts . It was not the
faulty implementation of Flowserve's computer systems that caused the Restatement, as the IOb-5
Defendants suggest in their 4/27/04 filing. In reality, the Company had understated cost of sales and
overstated inventory by deliberately failing to properly expense cost overruns associated with the
integration of IDP and IFC and instead left such costs in WIP inventory and because of a series of
inflated acquisitions . Flowserve's physical inventories revealed the inflated inventories carried o n
the Company's books year after year .
358 . Overstated Inventories : According to CW21, Flowserve often targeted failing
companies and purchased them for "pennies on the dollar ." Many of these companies threw in
assets and overstated quantities to increase their asking prices . CW21 stated that he/she found
quantities of acquired company inventories were many times overstated, and that assets like
equipment and office furniture were thrown in inventory categories . These overstated inventory
amounts were then entered into Flowserve's corporate books . CW15 independently confirmed
CW2l's statements . Examples of companies who overstated their inventory amounts include Kopp l
Companies and Invatek locations, acquired prior to the Class Period .
359 . Corporate Knowledge : According to CW2 1, when Flowserve's divisions conducte d
their physical inventories, the actual numbers disagreed with the overstated amounts on the corporat e
books . Employees tried to get the Company to do something about the discrepancy for years, as th e
discrepancy got larger with each acquisition . According to CW15, in mid-November 2002, the
Company found a $7 million overstatement in inventory count in the industrial services group .
Although it was brought to corporate management's attention, CW15 was informed that the
Company was going to leave things as they were . According to both CW15 and CW21, the $7
million overstatement came to light again in October 2003 when a physical inventory count did not
match with the corporate accounts .
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360 . Restatement Disclosures Not True : According to CW21 and CW 15, the industrial
services group 's problem of overstated inventory from Flowserve' s many acquisitions was likely
Company-wide because of Flowserve 's uniform "due diligence" practices . According to CW21,
Hornbaker's statements attributing the inventory problem to a faulty computer system were just not
true . Instead , the overstated inventory was emblematic of larger corporate problems and not just a n
implementation error.
361 . Restatement Just "Best Spin" : According to CW28, after the Class Period durin g
2003 and early 2004, there were heated conversations about the inventory "being off," costs being
too high, and, in general, that "the numbers were just way off." CW28 believes that the numbers in
the restatement were not ultimately accurate, but rather "the best spin" that defendants Greer and
Hombaker could muster . According to CW28, it was evident that the Flowserve executives,
including defendants Greer and Hornbaker, were "creating" what they wanted to report in th e
restatement.
362 . Flowserve' s Restatement More than Difficulties at Two Reporting Locations :
Any suggestion by defendants that the restatement was due to difficulties in converting to new
computer systems, was false and misleading because according to CW3 1, from the summer of 2003
to April 2004, the corporate finance department was consumed with exercises to prepare for the
restatement. Just when it seemed a particular issue was resolved, a division like Vernon or the
facilities in Spain or France came in with new information that had been missed, and the
reconciliation started over. According to CW3 1, at Flowserve "the numbers weren't really the
numbers," and inputs from the divisions kept changing . The way corporate dealt with these inputs
also kept changing as the internal deadline for the restatement (1Q04) kept approaching . The initial
restatement related exercise that began in early 2003 was focused on reconciliation of inventor y
accounts, primarily in the Pumps Division, but in others, as well . As this exercise began, however ,
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many other accounting discrepancies were identified by the va rious divisions, and it was as if the
finance departments of Flowse rve divisions were all simultaneously a ttempting to "clean up the
books." According to CW3 1, "every piece of our financials had been total cr*p" for the last three or
four years at least. CW3l's manager repeatedly said that the exercise was "our do -over, let's do it
right ." Because of the magnitude of adjustments being made by the divisions , CW31 said it was
"obvious" at the time of the restatement exercise , that divisions were seizing the opportunity to make
their own accounting accurate going back to the year 2000 .
363 . Restatement Due to PwC Scrutiny : According to CW33, the Flowserve restatement
of April 2004 was "all about PwC getting even with Flowserve ." CW33 explained that Hornbaker
and the Controller during the Class Period, Giddings, had been "all over" the PwC partner assigned
to Flowserve. CW33 said that the PwC employee in charge of the Flowserve account, Kathy
Humbreck ("Humbreck"), had recently been promoted to partner, and her first large assignment was
Flowserve . CW33 said that Hornbaker and Giddings "ran Humbreck ragged," resulting in a great
deal of animosity built up between Flowserve and PwC by the time of the Enron situation
Following the collapse of Enron, the "pendulum of power" - as CW33 describes it - swung to PwC ,
which then "wanted to come after Flowserve with a vengeance ." Whereas PwC might have worked
with Flowserve and allowed certain accounting treatments in prior years, nothing was going to ge t
by any longer .
364 . Cost Accounting Out-of-Control : According to CW33, the restatement of Apri l
2004 primarily focused on inventory, and in particular, the Flowserve UK, Etten Leur, Vernon and
perhaps Tawneytown plants . In those areas, it was clear from the Flowserve books that the
"controllers weren't controlling," and plant accounting for inventories were "out of control ."
Flowserve had not accurately accounted for in-process orders . CW33 said that the company was
"out of control" in terms of the accuracy of costs being assigned to in-process production orders .
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The costs were being "under expensed" and "over capitalized" and the finance department could not
ascertain where costs came from or when . According to CW33 , the accounting system tended to
check these costs into the balance sheet , but that the cost accounting for the orders coming through
never reached the income statement because there was no trail of what account costs had bee n
assigned to which orders . CW33 stated that there was no way to calculate which costs to pull out o f
stores' inventory or raw materials inventory to assign the costs to the correct job. CW33 said tha t
PwC was able to see the problem statistically and demanded explanations from Flowserve in earl y
2003 . Flowserve's lack of ability to answer PwC's questions was further compounded by employe e
and management turnover. CW33 said that Flowserve "tended to eat its own young," as Greer fire d
anyone who made him unhappy .
365 . SEC Begins Informal Inquiry : On 2/4/04, the Company received an informa l
inquiry notice from the SEC requesting the voluntary production of documents and informatio n
related to the 2/3/04 announcement .
366 . Flowserve 's Controller Resigns : On 2/15/04, Flowserve announced that its
controller for the Class Period, Kathleen Giddings resigned, effective immediately .
367 . Flowserve Restates : On 4/27/04, the Company issued its restatement and restated a
total of $23 .6 million of Flowserve's reported pretax earnings for the years ended December 31 ,
2000, 2001 and 2002 and first three quarters of 2003 . The lOb-5 Defendants have yet to reveal th e
truth but instead continue to deceive investors about the true reasons for Flowserve's decline i n
revenue and earnings and for its admittedly false accounting of costs and inventory .
368 . Flowserve Receives Wells Notice : On 5/25/04, Flowserve received a Wells Notic e
fromthe SEC related to a separate investigation regarding whether the Company violated Regulation
FD in reaffirming earnings guidance in an informal conversation with an analyst on Nov. 19, 2002 .
According to the notice, the staff is considering recommending that the SEC seek a cease and desis t
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order, in conjunction with civil penalties, against Flowserve, defendant Greer, and Flowserve' s
director of investor relations .
369 . SEC Commences Formal Order: On 6/2/04, Flowserve announced that the SEC had
issued a formal order of private investigation into issues regarding Flowserve's restatement and any
other issues that arise from the investigation .
370 . Dissension Between Greer and Hornbaker. According to CW28, in the month s
after the end of the Class Period and leading up to the restatement, there were frequent heate d
arguments between defendants Greer and Hornbaker . According to CW28, defendant Hombaker
would often say to defendant Greer, "I can't do that," or "I can't report it that way ." Defendant
Greer became extremely confrontational with defendant Hornbaker and yelled at her, "Yes, yo u
can!" or "We are going to do it that way ."
371 . Defendant Hornbaker Resigns : On 6/15/04, Flowserve announced that defendant
Hornbaker resigned from her position as vice president and CFO. According to CW28, when
Hombaker left in June 2004, she said that she was "glad to be out of there" because "things are
really bad . "
372 . Flowserve 's CAO Resigns . On 10/18/04, Flowserve announced that its Chief
Accounting Officer ("CAO"), Richard J . Guiltinan, had given notice of his intent to resign . Even
more surp rising was that by 10/25/04, Flowserve announced it had convinced Mr . Guiltinan to
remain as its CAO. Mr. Guiltinan had been named interim controller upon Giddings' departure i n
March 2004 . On June 17, 2004, Mr . Guiltinan was named vice president, controller, and CAO. Mr.
Guiltinan , a CPA, has more than 25 years of expe rience in accounting , finance, and genera l
management and performance improvement in a large, multinational company and a "Big Four"
accounting firm . Prior to joining Flowserve, Mr . Guiltinan had a 16-year career at Caltex Corp ., in a
number of senior finance and management positions, including chief financial officer an d
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comptroller . Before that, Mr . Guiltinan served with KPMG in New York and Dallas as a senior
manager, with nine years of public accounting experience in the financial, manufacturing and oil
industries. Mr. Guiltinan had only been with Flowserve for eight months. It was no surprise to
observers that Mr . Guiltinan was considering departing. According to CW25, the reason why
Flowserve "burned through so many accountants" is because of Flowserve's burying of losses in the
WIP inventory account . CW25 stated that accountants would quit or get fired after disagreeing with
this procedure .
373 . Flowserve Announces Amendment : On 10/26/04, Flowserve announced it woul d
delay the filing of its 2Q and 3Q04 filings with the SEC . According to its press release, Flowserve
plans on amending its previously announced financial results for 2Q04 . The changes include post-
closing adjustments and/or recently identified out-of-period expenses, relating to reconciliation of
intercompany and deferred tax accounts . In addition, Flowserve announced the existence of
weakness of certain internal controls .
374 . Flowserve Announces Possible Restatement : The 10/26/04 press release also stated
that depending on the amount of the out-of-period expenses, the company will assess whether a
restatement is needed for past periods . In addition, Flowserve announced the existence of material
weaknesses in its internal controls.
375 . Recent Adjustments Should Have Been Included in April Restatement :
According to CW3 1, the April restatement was to resolve not only inventory issues, but also to
reconcile the inter-company account issues and disputes that were the subject of this year-long
project. Therefore, according to CW31, the recent announcement of the inter-company account
issue should have been cleared up by the end of 2003, as part of a the April restatement .
376 . Flowserve 's Remaining Problems with Inter-Company Accounts : CW33 stated
that there were two "left-over" items from the April 2004 restatement . The first involved a problem
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with balances on "inter-company accounts" where the outside auditors wanted Flowserve to "fmish
the job." CW33 said this was an area where Flowserve tended not to enforce the company's own
policies for accounting procedures on inter-company accounts . The problem occurred where one
Flowserve company billed another, which decided for whatever reason that it would not pay that bill .
This created imbalances in inter-company accounts and CW33 described that Flowserve was "all
over the place" on these types of transactions .
377 . Flowserve's Remaining Problems with Deferred Taxes : The other issue in
Flowserve's delay in reporting to the SEC is deferred taxes . CW33 explained that Flowserve had
never done any of the detail work on this category from the time he/she arrived until the time of the
restatement in April 2004 . CW33 said that since Flowserve was not a big fixed-asset kind of
company, depreciation was not a large concern and had little or no effect on the way the company
calculated goodwill . PwC had known for years that the Company had not reconciled deferred tax
accounts, and it did not make any demands until the shift in power that occurred after the Enron
scandal. CW33 said that given the weak accounting by Flowserve overall, it simply did not track the
way "deferreds" were being accounted for in various plants, in various countries, in comparison to
the accounting treatments for plants in the U .S . There was no uniformity, no internal audit function
and no fixed assignment of responsibility . CW33 indicated that this lack of responsibility was
evident in the first restatement . PwC had known about a significant missing deferred tax entry
associated with the "cumulative translation adjustment." On Company loans to third parties, the
accounting and treasury departments for Flowserve had to work together to track cumulative
translation adjustments and perform the tax deferred entries associated with these . In 2000, when
Flowserve began to form a tax strategy for the Company, Flowserve made a number of inter-
company loans as part of tax planning . However, the finance department failed to track these like it
did on third-party loans for purposes of deferred tax analysis . The amount of the missing entry was
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approximately $ 18 million, and PwC was aware of this problem , but had not taken any action in
p rior years . According to CW33, the deferred tax issue went on PwC ' s "list of items to be cleaned
up" in the event that there was ever a restatement . CW33 said that post-Enron, balance sheet
balances became "real touchy," giving more attention to deferred tax issues . Suddenly, outside
accounting firms were all over companies to reconcile deferreds . PwC came to Flowserve in
January 2003 , indicating it would review the tax deferreds for Flowserve - but allowing Flowserve
to continue operations as is during the year . This was pitched directly to CW3 3 by the PwC partner,
who in turn, pitched it to Ho rnbaker to allow this review. Hornbaker got back to CW33, telling
CW33 that defendant Greer did not want any such thing because PwC was "just trying to get mor e
fees out of us ."
378 . Flowserve Delays SEC Filings : Despite the 10/26/04 announcement that Flowserv e
would be amending its 2Q and 3Q04 filings with the SEC and possibly restating for past periods ,
Flowserve has yet to file any of these documents with the SEC . Indeed, on 11/09/04, defendants
filed an NT-10Q filed on Form 12b-25 with the SEC stating that the Company was "working
diligently" to address and resolve the matters in the 10/26/04 press release, as well as to complet e
and file its amended 2Q report on Form 10-Q/A for the 2Q03 ; its 2Q report on Form 10-Q for 2Q04 ;
and its 3Q report on Form 10-Q for 3Q04 . As of the date of this Complaint, defendants have not
filed any substantive filings with the SEC since the 7/8/04 filing of Flowserve's 10-Q and l OQ/A for
1Q04 and 1Q03, respectively . This is a resounding silence of seven months .
379 . Second Restatement and Departure of CEO Greer: On February 7, 2005, the fina l
shoe dropped . Flowserve announced that the additional restatement discussed to be less than $10
million on 10/26/04 (the "Second Restatement") was estimated to be less than $20 million
"cumulative net reduction in net income," but this estimate was "subject to revision following further
ongoing analysis ." In addition, Flowserve announced that "Chairman, President and Chie f
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Executive Officer C . Scott Greer and the company's board of directors have jointly agreed that Greer
will not renew his contract with the company when it expires on June 30, 2005 . "
380 . Greer Admits IDP Inefficiencies : In a recent conference call on 2/8/05, defendant
Greer admitted that the pump division suffered after the IDP acquisition, losing market shar e
because of declines in on- time delivery and cycle times (the time for completing the pump
production) . In fact, Greer acknowledges that in 2002, Flowserve was only at 70% on time delivery :
[T]here is a much longer lead time between booking and sales in pumps than seals . . .what you would be looking at is a period of time where we were consolidating ourpump division, in other words the Ingersoll Dresser Pump acquisition along withFlowserve's existing business, led to a decline in -on time delivery, [J cycle timeswere impacted and obviously bookings were impacted, and . . . . sales, vis a vis where
the competition were the overall market, we were actually losing market share in
the period of 2002 and 2003 . Beginning 2003, . . . we started to improve that . . . .
[DJuring this period of time [20021, we were at the low point 70% on time delivery .
381 . Operation Scrub : During the 2/8/05 conference call, Greer and Flowserve's new
CFO, Blinn, discussed the Second Restatement, internally called "Operation Scrub," and stated tha t
the formal release of the restatement would not happen until 2Q or 3Q 2005 . Blinn stated that in
addition to the material weaknesses outlined in Flowserve's press release of 10/26/04, there would
also be additional material internal control weaknesses revealed in the Second Restatement .
P. Applicability of Presumption of Reliance : Fraud-o n-the -MarketDoctrine
3 82 . At all relevant times, the market for Flowserve's securities was an efficient market fo r
the following reasons, among others :
(a) Flowserve's stock met the requirements for listing, and was listed and
actively traded, on the NYSE, a highly efficient and automated market ;
(b) As a regulated issuer, Flowserve filed periodic public reports with the SE C
and the NYSE ;
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(c) Flowserve regularly communicated with public investors via establishe d
market communication mechanisms, including through regular disseminations of press releases on
the national circuits of major newswire services and through other wide-ranging public disclosures ,
such as communications with the financial press and other similar reporting services ; and
(d) Flowserve was followed by several securities analysts employed by major
brokerage firms, who wrote reports that were distributed to the sales force and certain customers o f
their respective brokerage firms . Each of these reports was publicly available and entered the
public marketplace.
383 . As a result of the foregoing, the market for Flowserve's securities promptly digeste d
current information regarding Flowserve from all publicly available sources and reflected such
information in Flowserve's stock price . Under these circumstances, all purchasers of Flowserve's
securities during the Class Period suffered similar injury through their purchase of Flowserve's
securities at artificially inflated prices, and a presumption of reliance applies .
Q. No Safe Harbor
384. The statutory safe harbor provided for forward -looking statements under certain
circumstances does not apply to any of the allegedly false statements pled in this complaint. Many
of the specific statements pled herein were not identified as "forward- looking statements" when
made. To the extent there were any forward- looking statements, there were no meaningful
cautionary statements identifying important factors that could cause actual results to differ materially
from those in the purportedly forward- looking statements . Alternatively, to the extent that the
statutory safe harbor does apply to any forward-looking statements pled herein, the 10b-5
Defendants are liable for those false forward- looking statements because, at the time each of those
forward-looking statements was made, the particular speaker knew that the particular forward-
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looking statement was false, and/or the forward- looking statement was authorized and/or approve d
by an executive officer of Flowserve who knew that those statements were false when made .
II. Violation of Sections 11 and 15 of the Securities Act (Defendants Flowserve,Greer, Hornbaker, PwC, BofA and CSFB)
A. Jurisdiction and Venu e
385 . The claims asserted herein arise under §§ 11 and 15 of the Securities Act, 15 U.S .C .
§§77k and 77o . Jurisdiction is conferred pursuant to §22 of the Securities Act, 15 U.S.C. §77v .
386. Venue is proper in this Dist rict pursuant to §22 of the Securities Act, 15 U.S.C. §77v.
Flowserve maintains its principal place of business in this District, and many of the acts an d
practices complained of herein occurred in substantial part in this District .
B. The Parties
387. Plaintiff Massachusetts State Carpenters Pension Fund ("Carpenters") purchase d
shares of Flowserve common stock issued in the 11/01 offering, pursuant to and traceable to the
Shelf Registration Statement and Prospectus filed on 5/31/01 and amended on 7/2/01 (the "Shelf
Registration"), and the 11/16/01 Prospectus Supplement filed pursuant thereto and suffered damages
as a result thereof. Carpenters also purchased shares of Flowserve common stock issued in the 4/02
Offering, pursuant to and traceable to the Shelf Registration and the 4/16/02 Prospectus Supplement
filed pursuant thereto and suffered damages as result thereof Carpenters' certification is attached
hereto as Ex . D .
388 . Plaintiff Pipefitters, Locals 522 & 633 Pension Trust Fund ("Pipefitters") purchased
shares of Flowserve common stock issued in November 2001 offering, pursuant to and traceable to
the Shelf Registration and 11/16/01 Prospectus Supplement filed pursuant thereto, and suffere d
damages as result thereof. Pipefitter's certification is attached hereto as Ex . C .
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389. Lead plaintiff Alaska Fund purchased shares of Flowserve common stock issued in
the April 2002 offering, pursuant to and traceable to the Shelf Registration and 4/16/02 Prospectu s
Supplement filed pursuant thereto and suffered damages as a result thereof.
390. Defendant Flowserve issued and sold 16 .13 million shares of common stock in the
November 2001 and April 2002 offerings, pursuant to the Shelf Registration filed on 5/31/01 and
amended on 7/2/01, and the 11/16/01 and 4/16/02 Prospectus Supplements thereto (the "Offering
Materials") for the for total proceeds of $452 .655 million. The Offering Materials contained
materially false statements in violation of §§11 and 15 of the Securities Act .
391 . Defendant PwC, at all times relevant to this action, served as the Company's outsid e
independent auditors and audited the financial statements contained in the Company's Shelf
Registration and the November 2001 and April 2002 Prospectus Supplements . PwC issued
unqualified audit reports on Flowserve's fiscal year 2000, 2001 and 2002 financial statements .
PwC's 2000 audit report was incorporated into the Offering Materials and its 2001 audit report was
incorporated into the April Prospectus Supplement . PwC is a Delaware corporation, headquartered
at 1177 Avenue of the Americas, New York, New York. Process may be served on PwC through its
registered agent, CT Corp System at 1021 Main Street, Suite 1150, Houston, TX 77002 .
392 . Bank of America LLC ("BofA") and Credit Suisse First Boston LLC ("CSFB") eac h
served as the underwriters on the 11/16/01 offering and the 4/16/02 offering .
393 . Defendant BofA's commercial banking arm, Bank of America, N .A., served as th e
Administrative Agent, Swingline Leader, and Collateral Agent for the lenders of the Credit
Agreement dated as of 8/8/00 and as amended 11/9/01 and 5/2/02 . BofA is a Delaware corporation,
headquartered in Charlotte, North Carolina. Process may be served on BofA through its registered
agent , CT Corp System, at 350 N . St . Paul Street, Dallas, TX 75201 .
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394. Defendant CSFB's commercial banking arm served as the Syndication Agent of th e
Credit Agreement dated as of 8/8/00 and as amended 11/9/01 and 5/2/02 . CSFB is a Delaware
corporation, headquartered in New York, New York . Process may be served on CSFB through its
registered agert, Corporation Service Company, d/b/a CSC Lawyers Incorporating Servic e
Company, 701 Brazos Street, Suite 1050, Austin, TX 78701 .
395. Defendants BofA and CSFB 's negligent failure to conduct adequate due diligence in
connection with the November 2001 and April 2002 Prospectus Supplements and offerings pursuant
thereto was based, in part, on their conflict of interest with their commercial banking arms which
provided the 8/8/00 Credit Agreement to Flowserve . The proceeds of the November 2001 and Apri l
2002 offerings were each intended to provide funds for substantial payments to decrease Flowserve's
indebtedness on this Credit Agreement . Further, BofA's commercial banking arm, as the
Administrative Agent, stood to gain more than $1,000,000 in amendment fees from the November 9,
2001 Credit Agreement Amendment if an offering was completed by the end of 2001 .
396. Defendant Greer, at all times relevant to this action, served as the Company' s
Chairman, President, CEO and Director . By virtue of, among other things, his role as the highes t
executive officer and Director of Flowserve and the primary voice of the Company in filings wit h
the SEC, conference calls and interviews, Greer is a control person of the Company as that term i s
construed by the federal securities laws . Defendant Greer drafted, prepared and signed the Shel f
Registration pursuant to which the November 2001 and April 2002 Prospectus Supplements were
filed .
397. Defendant Hombaker, at all times relevant to this action, served as the Company' s
Vice President and CFO . By virtue of, among other things, her role as an officer of Flowserve an d
her participation in filings with the SEC, Hombaker is a control person of the Company as that term
is construed by the federal securities laws . Defendant Hornbaker drafted, prepared and signed the
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Shelf Registration pursuant to which the November 2001 and April 2002 Prospectus Supplements
were filed.
398. As officers and controlling persons of a publicly-held company whose common stock
was, and is, registered with the SEC pursuant to the Securities Act, 15 U .S .C. §78, and was traded on
the NYSE, and governed by the provisions of the federal securities laws, Greer and Hornbaker each
had a duty to disseminate promptly accurate and truthful information with respect to the Company's
financial condition and performance, growth, operations, financial statements, business, products,
markets, management, earnings and present and future business prospects, and to correct any
previously issued statements that had become materially misleading or untrue, so that the market
price of the Company's publicly-traded securities would be based upon truthful and accurate
information . Greer and Hornbaker's misrepresentations and omissions in the Offering Materials
violated these specific requirements and obligations .
399. Both defendants Greer and Hornbaker drafted, prepared and/or otherwise approved
the filing of the Shelf Registration, the November Prospectus Supplement included in the
Company's Registration Statement on Form S-3, filed with the SEC on 11/16/01, and the April
Prospectus Supplement included in the Company's Registration Statement on Form S-3, filed with
the SEC on 4/16/02 .
400. Each of the defendants owed purchasers of the stock the duty to make a reasonable
investigation of the statements contained in the offering materials, and all statements incorporated by
reference were true and that there was no omission of any material fact required to be stated in order
to make the statements contained therein not misleading . They failed to make such an investigation,
and false statements of material fact were included in the Offering Materials in violation of § § 11 and
15 of the Securities Act.
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C. Liability Under Sections 11 and 15 of the Securities Act
401 . This claim is brought on behalf of a class of all purchasers of Flowserve common
stock issued pursuant to and traceable to Flowserve's Offering Materials who were damage d
thereby. The purchasers are pursuing remedies under the Securities Act against Flowserve, Greer ,
Hombaker, PwC, BofA and CSFB .
402 . Flowserve is liable under § 11 because its Offering Materials, when they became
effective, contained untrue statements of material fact or omitted to state material facts required to b e
stated therein or necessary to make the statements therein not misleading . 15 U.S .C. §77k(a)(1) .
403. Defendants Greer and Hornbaker, as signatories to the Offering Materials, are liable
for all false or misleading statements of material fact contained therein . 15 U.S.C. §77k(a)(1) .
Further, as CEO and CFO respectively, defendants Greer and Hombaker are liable as control persons
under §15 for the false statements contained in the Offe ring Mate rials . 15 U.S.C. §77o .
404. Defendant PwC, having consented to the inclusion of its audit reports, is liable fo r
false statements contained in any part of the Offering Materials that PwC has been named, with it s
consent, as having prepared or ce rt ified. 15 U.S .C. §77k(a)(4) .
405. Defendants BofA and CSFB, as underwriters of the public offerings, are liable for all
false statements of mate rial fact contained in the Offe ring Mate rials. 15 U.S .C. §77k(a)(5) .
406. As a result of employing the improper accounting practices throughout the clas s
period alleged herein, Flowserve was ultimately forced to restate its financial statements for 2000 ,
2001, 2002 and the first three quarters of 2003, resulting in decreased net income by 18 .3%, 600 .6%,
and 14.2% in the years 2000, 2001 and 2002, respectively.
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Net Income (in $000's)
Reported Restated DifferenceFY00 13,241 10,822 18 .3%FY01 (1,497) (10,488) -600.6%FY02 53,025 45,497 14.2%
Total 64,769 45,831 29.2%
1 . The Shelf Registration Statement
407 . Flowserve's Shelf Registration became effective on 11/16/01 .
408. As an exhibit to the Shelf Registration, PwC filed a consent to this incorporation b y
reference of its audit reports and being named as experts in auditing and accounting :
We hereby consent to the incorporation by reference in this RegistrationStatement on Form S-3, Amendment No . 1, of our report dated February 5, 2001relating to the consolidated financial statemerts, which appears in the 2000 AnnualReport to Shareholders, which is incorporated by reference in FlowserveCorporation's Annual Report on Form 10-K for the year ended December 31, 2000 .We also consent to the incorporation by reference of our report dated February 5,
2001 relating to the financial statement schedule, which appears in such AnnualReport on Form 10-K. We also consent to the reference to us under the heading
"Experts" in such Registration Statement .
409 . False Statement : The Shelf Registration incorporated Flowserve's Annual Report on
Form 10-K ("10-K") for 2000 . The 2000 10-K falsely reported that Flowserve had net earnings of
$ 13.2 million for 2000, and net earn ings per share of $0 .35 .
410 . As Admitted in Restatement : The financial results reported in the 2000 10-K wer e
materially false and misleading . Their falsity is shown by the restated and significantly lower 200 0
financial results released by Flowserve on 4/27/04 . Flowserve originally reported earnings of $13 . 2
million or $0 .35 per share for FY00 ; after restating, Flowserve claimed FY00 earnings of just $10 . 8
million or $0.29 per share .
411 . As Admitted in Restatement : Flowserve's restatement of its financial statement s
included in its 10-K is also an admission that the financial statements therein were based o n
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information available to defendants at the time the results were originally reported . 10 Further, they
were false when they were incorporated into the Shelf Registration .
412 . False Statement : With the consent of defendant PwC, the Shelf Regis tration
incorporated PwC's 2/5/01 unqualified audit report on Flowserve's financial statements for 2000 as
follows:
To The Board of Directors and Shareholders of Flowserve Corporatio n
In our opinion, the accompanying consolidated balance sheet and the relatedconsolidated statements of income, comprehensive (loss) income, shareholders'equity and cash flows present fairly, in all material respects, the financial position ofFlowserve Corporation and its subsidiaries at December 31, 2000, and the results oftheir operations and their cash flows for the year then ended in conformity withaccounting principles generally accepted in the United States of America . Thesefinancial statements are the responsibility of the Company's management ; ourresponsibility is to express an opinion on these financial statements based on ouraudit . We conducted our audit of these statements in accordance with auditingstandards generally accepted in the United States of America, which require that weplan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement . An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation . We believethat our audit provides a reasonable basis for our opinion .
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLPDallas, TexasFebruary 5, 200 1
413 . False Statements : PwC's statement that Flowserve's consolidated balance sheets ,
statements of income, comprehensive (loss) income, shareholders' equity and cash flows fairly
presented Flowserve's financial position at December 31, 2000 and the results of its operations fo r
10 In re Sunbeam Sec. Litig ., No . 98-8258 -Civ.-Middlebrooks (S .D . Fla . ), SECAmicus CuriaeBrief Regarding Defendants ' Motion In Limine to Exclude Evidence of the Restatement and theRestatement Report (filed Jan. 31 , 2002))("GAAP only allows a restatement of prior financialstatements based upon information that existed at the time the financial statements were prepared .") .
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2000 in conformity with GAAP was false. Flowserve's financial statements were materially false, as
discussed above in ¶¶406-409 . Further, they were not reported in accordance with GAAP, as
detailed below and acknowledged by Flowserve in its Restatement . PwC's statement that it
conducted its audits of Flowserve's December 31, 2000 financial statements in "conformity with
accounting principles generally accepted in the United States of America" was also false, as it s
audits were not conducted in accordance with such standards, as discussed below in ¶¶450-452 .
414 . As Admitted in Restatement : The financial results reported in the 2000 10-K were
not reported in accordance with GAAP and SEC Regulation S-X (17 C .F.R. §210 .4-01(a)(1)) . The
Company violated the following fundamental GAAP principles, as well as the following GAA P
principles :
415 . The principle that financial reporting should provide information that is useful to
present and potential investors and creditors and other users in making rational investment, credi t
and similar decisions was violated (FASB CON No. 1, ¶34) ;
416 . The principle that financial reporting should provide information about the economi c
resources of an enterprise, the claims to those resources, and effects of transactions, events an d
circumstances that change resources and claims to those resources was violated (FASB CON No . 1 ,
¶40) ;
417 . The principle that financial reporting should provide information about ho w
management of an enterprise has discharged its stewardship responsibility to owners (stockholders )
for the use of enterprise resources entrusted to it was violated . To the extent that management offer s
securities of the enterprise to the public, it voluntarily accepts wider responsibilities fo r
accountability to prospective investors and to the public in general (FASB CON No . 1, ¶50) ;
418 . The principle that financial reporting should provide information about an
enterprise's financial performance during a period was violated . Investors and creditors often use
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information about the past to help in assessing the prospects of an enterprise . Thus, although
investment and credit decisions reflect investors' expectations about future enterprise performance ,
those expectations are commonly based at least partly on evaluations of past enterprise performanc e
(FASB CON No. 1, ¶42) ;
419. The principle that financial reporting should be reliable in that it represents what i t
purports to represent was violated . That information should be reliable as well as relevant is a notio n
that is central to accounting (FASB CON No. 2, ¶¶58-59) ;
420. The principle of completeness, which means that nothing is left out of the informatio n
that may be necessary to insure that it validly represents underlying events and conditions wa s
violated (FASB CON No . 2, ¶79); and
421 . The principle that conservatism be used as a prudent reaction to uncertainty to try t o
ensure that uncertainties and risks inherent in business situations are adequately considered wa s
violated. The best way to avoid injury to investors is to try to ensure that what is reported represent s
what it purpo rts to represent (FASB CON No. 2, ¶¶95, 97) .
422 . False Statement : Flowserve's 2000 10-K included, as part of Exhibit 12, a "Report
of Management," signed by Greer and Hornbaker, which stated :
Management maintains a system of internal controls, which in management's opinionprovides reasonable assurance that assets are safeguarded and transactions properlyrecorded and executed in accordance with management's authorization . The internalcontrol system is supported by internal audits and is tested and evaluated by theindependent auditors in connection with their annual audit .
423 . As Admitted in the Amended 2002 10-K: On 4/27/04, Flowserve amended its Form
10-K for 2004 . In the amended 10-K, Flowserve admitted that it had "weaknesses in interna l
controls over the implementation of computer systems, recording inventory amounts and relate d
costs, account reconciliation procedures, manual journal entry procedures and monitoring o f
compliance with procedures." Flowserve also admitted that "in February 2004, PwC advised th e
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Audit/Finance Committee that these internal control issues collectively constituted material
weaknesses as defined in Statement of Auditing Standards No. 60 ."
424 . As Admitted in 10/26/04 Form 8-K: On 10/26/04, Flowserve issued a press release ,
filed as an exhibit to Form 8-K, admitting that it has " certain material weaknesses in its internal
controls," some of which involve past periods . Flowserve admitted in the press release that it ma y
have to restate those past periods.
2. The 11/16/01 Prospectus Supplement
425 . The November Prospectus Supplement comprised the 11/ 16/01 Supplement and the
Prospectus . It incorporated the 2000 10-K, its consolidated financial statements, PwC's audit report
for 2000, and the Report of Management regarding internal controls .
426 . False Statement : As detailed above in ¶¶406 and 409, Flowserve's 2000 10- K
contained materially false and misleading statements about Flowserve's financial results .
427 . As Admitted in Restatement : As detailed above in ¶¶409-411, and acknowledged b y
Flowserve in its Restatement, the 2000 10-K and associated financial statements were materiall y
false and misleading at the time they were made . The false statements in the 2000 10-K were als o
false and misleading at the time Flowserve issued the November Prospectus Supplement .
428 . False Statement : As detailed above in ¶412, PwC falsely represented that
Flowserve's 2000 10-K and the consolidated financial statements were reported in accordance with
GAAP .
429 . As Admitted in the Restatement : As detailed above in ¶¶413 and 421, Flowserve' s
2000 10-K and consolidated financial statements were not repo rted in accordance with GAAP .
430 . False Statement : As detailed above in ¶422, the Report of Management falsel y
represented that Flowserve' s management 's system of internal controls provided "reasonabl e
assurance that assets [were] safeguarded and transactions properly recorded and executed ."
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` • •
431 . As Admitted in the Amended 2002 10-K : On 4/27/04, Flowserve amended its Form
10-K for 2004. In the amended 10-K, Flowserve admitted that it had "weaknesses in interna l
controls over the implementation of computer systems, recording inventory amounts and relate d
costs, account reconciliation procedures, manual journal entry procedures and monitoring o f
compliance with procedures ." Flowserve also admitted that "in February 2004, PwC advised the
Audit/Finance Committee that these internal control issues collectively constituted materia l
weaknesses as defined in Statement of Auditing Standards No. 60 . "
432 . As Admitted in 10 /26/04 Form 8-K: As detailed above in ¶424, Flowserve' s
systems of internal controls had material weaknesses which may now result in a further restatement .
3. The 4/16/02 Prospectus Statement
433 . Flowserve filed its 2001 10-K with the SEC on 3/12/02 .
434. The April Prospectus Supplement incorporated by reference Flowserve's 2001 For m
10-K, including PwC's unqualified audit report for 2001 .
435. As part of the ShelfRegistration , the April Prospectus Supplement also included th e
2000 10-K, including PwC's unqualified audit report for 2000 and the Report of Managemen t
regarding Flowserve's system of material controls . The April Prospectus Supplement thus containe d
the false statements alleged in ¶¶406-424 .
436. On 4/16/02, Flowserve announced the commencement of a second offering pursuant
to the Shelf Registration. The Prospectus Supplement, dated 4/16/02, became effective on 4/18/02 .
437 . False Statement : The 2001 10-K incorporated into the April Prospectus Supplemen t
contained the materially false statement that Flowserve's net loss for the year was $1 .5 million or
$0.04 per share .
438 . As Admitted in Restatement : As acknowledged by Flowserve on 4/27/04, th e
financial results reported in its 10-K for the year ending 12/31/01 was materially false an d
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misleading . For 2001, instead of losses of $1 .5 million or $0 .04 per share, Flowserve admitted in it s
Restatement that it lost $10 .5 million or $0.27 per share .
439 . False Statement : The 4/18/02 Prospectus Supplement incorporated, with PwC' s
consent, PwC's unqualified audit reports for 2001 and 2000, dated 2/5/02, as follows :
To The Board of Directors and Shareholders of Flowserve Corporatio n
In our opinion, the accompanying consolidated balance sheets and the relatedconsolidated statements of operations, comprehensive loss, shareholders' equity andcash flows present fairly, in all material respects, the financial position of Flowserve
Corporation and its subsidiaries at December 31, 2001 and 2000, and the results oftheir operations and their cash flows for the years then ended in conformity withaccounting principles generally accepted in the United States of America . Thesefinancial statements are the responsibility of the Company's management ; ourresponsibility is to express an opinion on these financial statements based on our
audits . We conducted our audits of these statements in accordance with auditingstandards generally accepted in the United States of America, which require that we
plan and perform the audit to obtain reasonable assurance about whether the financialstatements arefree ofmaterial misstatement . An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements,assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation . We believethat our audits provide a reasonable basis for our opinion.
As discussed in Note 5 to the consolidated financial statements, the Companyadopted Statement of Financial Accounting Standards No . 133, "Accounting forDerivative Instruments and Hedging Activities," on January 1, 2001 .
/s/ PricewaterhouseCoopers LL P
PricewaterhouseCoopers LLPDallas, TexasFebruary 5, 2002
440 . As Admitted in Restatement : PwC's statement that Flowserve's consolidate d
balance sheet, statements of income, comprehensive (loss) income, shareholders' equity and cash
flows fairly present Flowserve's financial position at December 31, 2001 and 2000 and the results o f
its operations for those years in conformity with generally accepted accounting principles was false .
As discussed above in ¶¶408 and 437, Flowserve' s financial results were not fairly presented: net
earnings were overstated by 18 .3% in 2000 and net loss was understated by 600.6% in 2001 .
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Further, Flowserve ' s consolidated financial statements were not reported in accordance with GAAP,
as detailed above in ¶¶414-421, and acknowledged by Flowserve in its Restatement . PwC's
statement that it conducted its audits of Flowserve's December 31, 2001 and 2000 financia l
statements in "conformity with accounting principles generally accepted in the United States of
America" was false, as its audits were not conducted in accordance with such standards, as discusse d
below in ¶¶449-452 .
441 . False Statement : Flowserve's 2001 10-K included, as part of Exhibit 12 .1, a "Report
of Management," signed by Greer and Hornbaker which stated : Management maintains a system o f
internal controls, which in management's opinion provides reasonable assurance that assets ar e
safeguarded and transactions properly recorded and executed in accordance with management' s
authorization. The internal control system is supported by internal audits and is tested and evaluate d
by the independent auditors in connection with their annual audit .
442 . As Admitted in the Amended 2002 10-K: On 4/27/04, Flowserve amended its Form
10-K for 2004. In the amended 10-K, Flowserve admitted that it had "weaknesses in interna l
controls over the implementation of computer systems, recording inventory amounts and related
costs, account reconciliation procedures, manual journal entry procedures and monitoring o f
compliance with procedures ." Flowserve also admitted that "in February 2004, PwC advised the
Audit/Finance Committee that these internal control is sues collectively constituted materia l
weaknesses as defined in Statement of Auditing Standards No . 60 ."
443 . As Admi tted in 10/26/04 Form 8 -K : On 10/26/04, Flowserve issued a press release,
filed as an exhibit to Form 8-K, admitting that it has "certain material weaknesses in its interna l
controls," some of which involve past periods . Flowserve admitted in the press release that it ma y
have to restate those past periods .
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• 1]
444. False Statement : In addition, the 4/16/02 Prospectus Supplement discusse d
Flowserve's debt covenants and provided, among other things, that "[a]t December 31, 2001, we [th e
Company] were in compliance with these covenants . "
445 . As Admitted in Restatement : As acknowledged by Flowserve in its Restatement,
this statement was materially false and misleading at the time it was made : On 12/31/01, Flowserv e
was not in compliance with its loan covenants .
4. PwC Did Not Conduct Audits in Conformity with GenerallyAccepted Auditing Statements
446. The Shelf Registration stated that the financial results had been reviewed and certifie d
by Flowserve's independent auditors, PwC :
The consolidated financial statements incorporated in this Prospectus byreference to the Annual Report on Form 10-K for the year ended December 31, 2000,have been so incorporated in reliance on the report of PricewaterhouseCoopers LLP,independent accountants given on the authority of said firm as experts in auditingand accounting .
447. The November Prospectus Supplement stated that the financial results had been
reviewed and certified by Flowserve's independent auditor, PwC :
The consolidated financial statements incorporated in this Prospectus by reference tothe Annual Report on Form 10-K for the year ended December 31, 2000, have beenso incorporated in reliance on the report of PricewaterhouseCoopers LLP,independent accountants given on the authority of said firm as experts in auditingand accounting .
448 . The April Prospectus Supplement stated that the fin ancial results had been reviewed
and certified by Flowserve's independent auditor, PwC :
The consolidated financial statements of Flowserve Corporation as of
December 31, 2001 and 2000 and for each of the two years in the period endedDecember 31, 2001 incorporated in this prospectus supplement by reference to itsAnnual Report on Form 10-K for the year ended December 31, 2001, have been soincorporated in reliance on the report of PricewaterhouseCoopers LLP, independentaccountants, given on the authority of said firm as experts in auditing and
accounting .
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449. PwC's statements quoted in ¶¶446-448 that it conducted its audits of Flowserve' s
December 31, 2000 and 2001 financial statements in accordance with auditing standards generall y
accepted in the United States of America were false, as its audits were not conducted in accordanc e
with such standards .
450. PwC 's audits did not conform to United States Audit Standards ("AU"). For
example , PwC's audits did not conform to AU §331, a standard relating to "Invento ries ," which
requires that an auditor who audits and opines on an entity' s financial statements must be present to
observe the client's year-end physical invento ry count as part of his procedures to satisfy himself
that invento ry is properly stated .
451 . Flowserve conducted widespread end-of-period inventory counts at least annually,
and at least one confidential witness, CW20, has confirmed that PwC was indeed present and
assisted each year in the wall-to-wall physical inventory conducted at the Vernon facility . PwC was
required by audit standard AU §331 to observe such inventory counts and , had they not been
negligent, would have determined during such an observation that Flowserve's inventory wa s
inflated and cost of sales understated in the Company's 2000 and 2001 financial statements . PwC
would have made this determination had they not been negligent because, among other things, ha d
they complied with Generally Accepted Auditing Standards ("GAAS"), they would have discovered
that the results of the physical inventory were materially different from the inventory balance s
carried on Flowserve' s accounting system . Additionally, because PwC did not conduct its audit in
accordance with GAAS, including AU §331, it was negligent in failing to determine that the
inflation of the inventory balance and associated understatement of cost-of-sales caused Flowserv e
to not be in compliance with debt covenants specified under its senior credit facilities . Indeed, at
least one confidential witness , CW23, has confirmed that PwC was present and assisted each year
during the Class Period with the wall-to-wall physical inventory at the Vernon facility .
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•
452. Similarly, AU §319, Consideration of Internal Control in a Financial Statement Audit ,
requires that an auditor perform procedures to understand and assess the reliability of the system o f
internal control and the risk that the system may not work as planned . During PwC's audits of
Flowserve's 2000 and 2001 financial statements, PwC should have obtained an understanding of and
assessed the effectiveness of the internal controls related to inventory and cost of sales . Because
PwC did not conduct its audit in accord ance with GAAS, including AU §319, they were negligent in
not determining that the Company' s internal controls over inventory could not be relied upon to
ensure that the Company's inventory and cost of sales were accurately reported .
5. BofA's and CSFB's Conflicted Role in the Offerings
453. BofA and CSFB were paid nearly $2 million each in underw riter fees by Flowserve in
connection with the November 2001 offering . The November Prospectus Supplement failed to
disclose that BofA's and CSFB's commercial banking arm, were Flowserve's lenders under it s
senior credit facility . Nor did the Supplement disclose that BofA' s commercial banking arm was the
Administrative Agent for Flowserve's 8/8/00 Credit Agreement and 11/9/01 Amendment thereto ,
and that, as such, it would receive amendment fees of over $1 million if Flowserve completed a
public offering before the end of 2001 . Instead, the November Prospectus Supplement stated merel y
that, "[a]ffiliates of certain of the underwriters participate in our senior credit facilities," an d
identified those underwriter affiliates only in a document incorporated by reference in anothe r
document incorporated by reference in the Prospectus . Such double incorporation by reference di d
not adequately inform investors of BofA's and CSFB's conflict of interest .
454. On 1/25/02, CSFB re-initiated coverage on Flowserve with a "Buy" rating .
455 . In connection with Flowserve's April offering, BofA was paid $2 .23 million an d
CSFB was paid $3 .44 million in underw riter fees by Flowserve. The April Prospectus Supplement
did not disclose that BofA's commercial banking arm was the Administrative Agent for Flowserve' s
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senior credit facility, nor that as the Administrative Agent, it would be entitled to substantia l
amendment fees when Flowserve amended the credit Agreement in connection with the IF C
Acquisition . The April Prospectus Supplement disclosed only that the underwriters' affiliates wer e
lenders and "received or will receive customary fees ."
6. Post Offering Disclosures
456. Defendant's false financial statements created a false understanding among th e
investing public of how Flowserve was doing and what its prospects for the future were . Faced with
mounting problems, Flowserve acknowledged on 7/22/02 and 7/23/02 that business was weakening .
These statements, while continuing to conceal the truth, began to deflate investors ' expectations . In
reaction to Flowserve 's 7/22/02 and 7/23/02 announcement, the price of Flowserve common stock
fell over 37%, closing at $ 14 .55 per share on 7/23/02.
457. Defendants again acknowledged that its business was weakening on 9/27/02 . Again,
without revealing Flowserve's true financial situation, Flowserve further deflated investo r
expectations . Market reaction to the Company's disclosures about the earnings shortfall was swift
and severe as the price of Flowserve common stock fell over 38%, closing at $8 .70 per share on
9/27/02, a decline of more than 72% from the April 2002 Offering price of $31 .50 and a 65% decline
form the November 2001 Offering price of $23 .50 .
III. Plaintiffs ' Class Action Allegations
458. Plaintiffs bring this action as a class action pursuant to Fed . R. Civ. P. 23(a) and
(b)(3) on behalf of a class, consisting of all those who purchased the securities of Flowserve durin g
the Class Period, inclusive and who were damaged thereby . Also included in the Class are al l
persons who purchased Flowserve common stock issued pursuant to and traceable to the Shelf
Registration and November and/or April Prospectus Supplements filed pursuant thereto (th e
"Class") . Excluded from the Class are defendants, the officers and directors of the Company, at al l
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•
relevant times, members of their immediate families and their legal representatives, heirs, successor s
or assigns and any entity in which defendants have or had a controlling interest.
459. The members of the Class are so numerous that joinder of all members i s
impracticable . Throughout the Class Period, Flowserve common shares were actively traded on th e
NYSE. While the exact number of Class members is unknown to plaintiffs at this time and can onl y
be ascertained through appropriate discovery, plaintiffs believe that there are hundreds or thousand s
of members in the proposed Class . Record owners and other members of the Class may be identifie d
from records maintained by Flowserve or its transfer agent and may be notified of the pendency o f
this action by mail, using the form of notice similar to that customarily used in securities clas s
actions .
460. Plaintiffs' claims are typical of the claims of the members of the Class, as all
members of the Class are similarly affected by defendants' wrongful conduct in violation of federa l
law that is complained of herein .
461 . Plaintiffs will fairly and adequately protect the interests of the members of the Clas s
and has retained counsel competent and experienced in Class and securities litigation . Common
questions of law and fact exist as to all members of the Class and predominate over any question s
solely affecting individual members of the Class . Among the questions of law and fact common t o
the Class are :
(a) Whether the federal securities laws were violated by defendants' acts a s
alleged herein;
(b) Whether statements made by defendants to the investing public during th e
Class Period misrepresented material facts about the business, operations and management o f
Flowserve; and
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• •
(c) To what extent the members of the Class have sustained damages and th e
proper measure of damages .
462. A class action is superior to all other available methods for the fair and efficient
adjudication of this controversy since joinder of all members is impracticable . Furthermore, as the
damages suffered by individual Class members may be relatively small, the expense and burden o f
individual litigation make it impossible for members of the class to individually redress the wrong s
done to them. There will be no difficulty in the management of this action as a class action .
FIRST CLAIM FOR RELIEF
Violation of Section 10(b) of the Exchange Act and Rule 10b-5 PromulgatedThereunder (Against Flowserve, Greer and Hornbaker )
463 . Plaintiffs repeat and reallege each and every allegation contained above as if fully se t
forth herein .
464. During the Class Period, the I Ob-5 Defendants carried out a plan, scheme and cours e
of conduct that was intended to and, throughout the Class Period, did : (a) deceive the investing
public, including plaintiffs and other Class members, as alleged herein ; (b) enable the Company to
complete two offerings of its common stock, raising hundreds of millions of dollars ; (c) enable
Flowserve insiders to sell millions of dollars of their personally held Flowserve common stock to the
unsuspecting public at artificially inflated prices ; and (d) cause plaintiffs and other Class members to
purchase Flowserve's securities at artificially inflated prices . In furtherance of this unlawful scheme,
plan and course of conduct, the lOb-5 Defendants, and each of them, took the actions set forth
herein .
465 . The lOb-5 Defendants (a) employed devices, schemes, and artifices to defraud ;
(b) made untrue statements of material fact and/or omitted to state material facts necessary to mak e
the statements not misleading ; and (c) engaged in acts, practices and a course of business that
operated as a fraud and deceit upon the purchasers of the Company's securities in an effort to
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•
maintain artificially high market prices for Flowserve securities in violation of § 10(b) of the
Exchange Act and Rule I Ob 5 . All of the I Ob- 5 Defendants are sued either as primary participants i n
the wrongful and illegal conduct charged herein or as controlling persons as alleged below .
466. The I Ob-5 Defendants, individually and in concert, directly and indirectly, by the use ,
means or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a
continuous course of conduct to conceal adverse material information about the business, operation s
and future prospects of Flowserve as specified herein .
467. These I Ob-5 Defendants employed devices, schemes and artifices to defraud while i n
possession of material adverse nonpublic information and engaged in acts, practices and a course o f
conduct as alleged herein in an effort to assure investors of Flowserve's value and performance and
continued substantial growth, which included the making of, or the participation in the making of,
untrue statements of material facts and omitting to state material facts necessary in order to make the
statements made about Flowserve and its business operations and future prospects, in the light of the
circumstances under which they were made, not misleading, as set forth more particularly herein ,
and engaged in transactions, practices and a course of business that operated as a fraud and decei t
upon the purchasers of Flowserve securities during the Class Period .
468. The l Ob-5 Defendants had actual knowledge of the misrepresentations and omissions
of material facts set forth herein or acted with reckless disregard for the truth in that they failed t o
ascertain and disclose such facts, even though such facts were available to them . The lOb- 5
Defendants' material misrepresentations and/or omissions were done knowingly or recklessly for th e
purpose and effect of concealing Flowserve's operating condition and future business prospects from
the investing public and supporting the artificially inflated price of its securities . As demonstrated
by the l Ob- 5 Defendants ' overstatements and misstatements of the Company' s business, operation s
and earnings throughout the Class Period, the lOb-5 Defendants, if they did not have actua l
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.!0 9
knowledge of the misrepresentations and omissions alleged, were deliberately reckless in failing t o
obtain such knowledge by consciously refraining from taking those steps necessary to discove r
whether those statements were false or misleading .
469. As a result of the dissemination of the mate rially false and misleading information
and failure to disclose material facts, as set forth above, the market price of Flowserve securities wa s
artificially inflated during the Class Period . In ignorance of the fact that market prices of
Flowserve's publicly traded securities were artificially inflated, and relying directly or indirectly on
the false and misleading statements made by the lOb-5 Defendants or upon the integrity of the
market in which the securities trade and/or on the absence of material adverse information that wa s
known to or recklessly disregarded by the IOb-5 Defendants but not disclosed in public statement s
by the lOb-5 Defendants during the Class Period, plaintiffs and the other Class members acquire d
Flowserve securities during the Class Period at artificially high prices and were damaged thereby .
470 . At the time of said misrepresentations and omissions , plaintiffs and other Clas s
members were ignorant of their falsity and believed them to be true . Had plaintiffs, the other
members of the Class and the marketplace known the truth regarding the problems Flowserve was
experiencing, which were not disclosed by the l Ob-5 Defendants, plaintiffs and other members of the
Class would not have purchased or otherwise acquired their Flowserve securities or, if they had
acquired such securities during the Class Period, would not have done so at the artificially inflated
prices they paid .
471 . By virtue of the foregoing, the 10b-5 Defendants have violated § 10(b) of the
Exchange Act and Rule IOb-5 promulgated thereunder .
472 . As a direct and proximate result of the l Ob- 5 Defendants' wrongful conduct, plaintiff s
and the other members of the Class suffered damages in connection with their respective purchases
and sales of the Company's securities during the Class Period .
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SECOND CLAIM FOR RELIEF
Violation of Section 20(a) of the Exchange Act
(Against Greer and Hornbaker)
473 . Plaintiffs repeat and reallege each and every allegation contained above as if fully se t
forth herein .
474. Greer and Hornbaker acted as controlling persons of Flowserve within the meaning of
§20(a) of the Exchange Act as alleged herein . By virtue of their high- level positions and their
ownership and contractual rights, participation in and/or awareness of the Company's operations
and/or intimate knowledge of the false fmanc ial statements filed by the Company with the SEC and
disseminated to the investing public, Greer and Hornbaker had the power to influence and control,
and did influence and control, directly or indirectly, the decision making of the Company, including
the content and dissemination of the various statements that plaintiffs contend are false and
misleading . Greer and Hornbaker were provided with or had unlimited access to copies of the
Company's reports, press releases, public filings and other statements alleged by plaintiffs to be
misleading prior to and/or shortly after these statements were issued and had the ability to prevent
the issuance of the statements or cause the statements to be corrected .
475. In particular, Greer and Hornbaker had direct and supervisory involvement in the day-
to-day operations of the Company and, therefore, are presumed to have had the power to control o r
influence the particular transactions giving rise to the securities violations as alleged herein and
exercised the same .
476. As set forth above, Flowserve and Greer and Hornbaker each violated § 10(b) an d
Rule 10b 5 by their acts and omissions as alleged in this Complaint . By virtue of their positions as
controlling persons, Greer and Hornbaker are liable pursuant to §20(a) of the Exchange Act. As a
direct and proximate result of Greer and Hornbaker's wrongful conduct, plaintiffs and othe r
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4 • •
members of the class suffered damages in connection with their purchases of the Company securitie s
during the Class Period .
THIRD CLAIM FOR RELIEF
Violation of Section 11 of the Securities Act for the Offering(Against All Defendants)
477. Plaintiffs Alaska Fund, Carpenters and Pipefitters repeat and reallege ¶¶385-462 ,
above except to the extent any paragraph alleges that defendants' misconduct was done intentionally,
knowingly or with a reckless disregard for the truth, or otherwise sounds in fraud . This Claim for
Relief is brought by plaintiffs pursuant to § 11 of the Securities Act, 15 U.S.C. §77k, on behalf of th e
Class against defendants Flowserve, Greer, Hombaker, PwC, BofA and CSFB and does not sound in
fraud . Plaintiffs do not repeat or reallege any paragraph that alleges defendants' misconduct wa s
done intentionally, knowingly or with a reckless disregard or otherwise sounds in fraud .
478. This claim is based on principles of strict liability, negligence and lack of due
diligence, but not fraud .
479. This claim is brought by plaintiffs who purchased Flowserve common stock pursuant
to the Shelf Registration Prospectus Supplements filed 11/16/01 and/or 4/16/02 ("Prospectu s
Supplements") . Plaintiffs and Class members acquired Flowserve common stock pursuant to and i n
reliance on the Offering Materials .
480. Greer and Hornbaker, as signatories of the Offering Materials and directors and/o r
officers of Flowserve, owed to the purchasers of the common stock in or traceable to the Offering
Materials, the duty to make a reasonable and diligent investigation of the statements contained in
them at the time they became effective to ensure that such statements were true and correct and that
there was no omission of material facts required to be stated in order to make the statement s
contained therein not misleading . As such, Greer and Hornbaker are liable to the Class .
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9
481 . None of the defendants made a reasonable investigation or possessed reasonabl e
grounds for the belief that the statements contained in the Offering Materials were true or that ther e
was no omission of material facts necessary to make the statements therein not misleading .
482. Defendants issued and disseminated, caused to be issued and disseminated, and
participated in the issuance and dissemination of materially false and misleading written statements
to the investing public that were contained in the Offering Materials . The Offering Materials
misrepresented or failed to disclose the facts set forth above . By reason of the conduct alleged
herein, each of the defendants violated § 11 of the Securities Act, employed a person who violated
§ 11 of the Securities Act and/or controlled a person who violated § 11 of the Securities Act .
483. PwC consented to the inclusion of its unqualified audit report on Flowserve's fisca l
2000 and 2001 financial statements in the Offering Materials . These financial statements were false
and misleading due to Flowserve's improper accounting as described herein . PwC also reviewed th e
Offering Materials which are alleged to have been misstated as described herein.
484. As issuer of the Offering Materials, Flowserve is strictly liable to plaintiffs and th e
other members of the Class for the misstatements and omissions .
485 . As underwriters of the November 2001 and April 2002 Offerings, BofA and CSFB
owed a duty to the Class not to have any conflict of interest with its "affiliates" and the shareholders,
and to conduct thorough and adequate due diligence .
486. As a direct and proximate result of the acts and omissions of the defendants, i n
violation of the Securities Act, the market price of Flowserve common stock was artificially inflated ,
and plaintiffs and the Class suffered substantial damages in connection with their purchases of
Flowserve common stock pursuant to the Offering Materials .
487. Plaintiffs Carpenters and Pipefitters acquired Flowserve common stock i n
Flowserve's November 2001 public offering of common stock . The stocks sold in this offering were
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issued pursuant to and traceable to the Shelf Registration and 11/16/01 Prospectus Supplemen t
issued .
488 . Plaintiffs Alaska Fund and Carpenters acquired Flowserve common stock in
Flowserve 's April 2002 public offering of common stock . The stock sold in this offering was issued
pursuant to and traceable to the Shelf Registration and 4/16/02 Prospectus Supplement .
489. Plaintiffs Alaska Fund, Carpenters, Pipefitters, and the other members of the Class
have sustained damages . The value of the common stock has declined substantially subsequent to ,
and due to, defendants' violations .
490. At the times plaintiffs purchased or otherwise acquired the common stock, they an d
the other members of the Offering Materials classes were without knowledge of the facts concerning
the wrongful conduct alleged herein and could not have reasonably discovered those facts prior t o
the issuance of the Offering Materials at issue. Less than one year has elapsed from the time when
plaintiffs discovered or reasonably could have discovered the facts upon which this action is based to
the time that they filed this action. Less than three years have elapsed from the time that the
securities upon which this claim for relief is brought were bona fide offered to the public and this
action was filed .
491 . Defendants, against whom this claim is asserted, were sellers, officers and/or
solicitors, or employers thereof, of sales of the common stock offered and sold in connection with
the Offering Materials . The acts of solicitation taken by defendants named in this Claim for Relief
included participation in the preparation and dissemination of the false and misleading Offering
Materials . The written and oral communications made in connection with the Offering Material s
contained untrue statements of material facts, omitted other facts necessary to make the statement s
made not misleading and failed to disclose material facts .
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• •
492. Defendants Flowserve, Greer, Hornbaker, PwC, BofA and CSFB offered for sale ,
solicited and/or were a substantial factor in the purchase by each Class member of the common stock
in the Offering. But for the participation by Flowserve, Greer, Hornbaker, PwC, BofA and CSFB or
someone who controlled or employed these defendants, including the solicitation pled herein, the
Offering could not and would not have been accomplished . These defendants participated in the
following wrongful acts :
(a) Actively and jointly drafting, revising and approving the Offe ring Materials
and other written selling materials by which the Offerings were made to the investing public . Such
written materials were "selling documents ," calculated by these defendants to create interest in
Flowserve common stock, and were widely distributed by these defendants for that purpose ;
(b) Finalizing the Offering Materials and causing them to become effective . But
for these defendants having drafted, filed and/or signed the Offering Materials, the Offerings coul d
not have been made; and
(c) Conceiving and planning the Offerings and together jointly orchestrating all
activities necessary to effect the Offerings by issuing the Proxy Statements, promoting the Notes
and supervising their distribution and ultimate sale to the investing public .
493 . Flowserve, Greer, Hombaker, PwC, BofA and CSFB were obligated to make a
reasonable and diligent investigation of the written and oral statements made in connection with th e
Offerings to ensure that such statements were true and that there was omission to state a material fac t
required to be stated in order to make the statements contained therein not misleading . Plaintiffs and
Class members who purchased or otherwise acquired their stock in the Offering did so based on th e
defective Offering Materials and/or the oral communications made in connection therewith . They
did not know of the untruths contained in the Registration Statements/Prospectuses and othe r
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statements made by defendants in connection with the Offerings or of the material omissions
therefrom .
FOURTH CLAIM FOR RELIEF
Violation of Section 15 of the Securities Act(Against Greer and Hornbaker)
494. Plaintiffs repeat and reallege ¶¶385-462 above . This Claim for Relief is brought by
plaintiffs pursuant to § 15 of the Securities Act, 15 U.S .C. §77o, on behalf of the Class against
defendan ts Greer and Hombaker and does not sound in fraud. Plaintiffs do not repeat or rea llege any
paragraph that alleges Greer and Hornbaker 's misconduct was done intentionally , knowingly or with
a reckless disregard or otherwise sounds in fraud .
495 . This claim is asserted against Greer and Hornbaker and is based on principles of stric t
liability, negligence and lack of due diligence, but not fraud .
496 . Greer and Hornbaker named in this claim acted as controlling persons of th e
Company within the meaning of §15 of the Securities Act . By reason of their senior management
positions and/or directorships or ownership of Flowserve stock, as alleged above, Greer and
Hornbaker named in this claim had the power to influence and exercised the same to cause
Flowserve to engage in the unlawful acts and conduct complained of herein.
497. By reason of such wrongful conduct, Greer and Hornbaker named in this claim ar e
liable pursuant to § 15 of the Secu rities Act. As a direct and proximate result of their wrongful
conduct, plaintiffs and the other members of the Class suffered damages in connection with thei r
purchases of Flowserve's stock during the Class Period .
PRAYER FOR RELIEF
WHEREFORE, plaintiffs pray for relief and judgment, as follows :
A. Determining that this action is a proper class action pursuant to Fed . R. Civ . P . 23(a)
and (b)(3) on behalf of the Class defined herein ;
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'A .w 0 0
B. Awarding plaintiffs and the members of the Class compensatory damages, includin g
rescissionary damages, where applicable ;
C. Awarding plaintiffs and the members of the Class pre-judgment and post-judgment
interest, as well as reasonable attorneys' fees, expert witness fees and other costs ;
D. Awarding extraordinary, equitable and/or injunctive relief as permitted by law, equit y
and federal statutory provisions sued hereunder, including rescission and the imposition of a
constructive trust, pursuant to Fed. R . Civ . P . 65 and any appropriate state law remedies ;
E. Ordering defendants Greer and Hornbaker to forfeit and reimburse Flowserve for any
bonus or other incentive-based or equity-based compensation received by them, and any profits
realized from the sale of securities during the time periods set forth in §304 of the Sarbanes-Oxle y
Act of 2002 ; and
F. Awarding such other relief as this Court may deem just and proper .
JURY TRIAL DEMANDE D
Plaintiffs hereby demand a trial by jury .
DATED: February 15, 2005 PROVOST & UMPHREY LAW FIRM, LLPJOE KENDALL
State Bar No . 11260700WILLIE C. BRISCOEState Bar No . 2400
LIE C. BRISCOE
3232 McKinney Avenue, Suite 700Dallas, TX 7520 4Telephone: 214/744-3000214/744-3015 (fax)
Liaison Counse l
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0
LERACH COUGHLIN STOIA GELLERRUDMAN & ROBBINS LL P
KIMBERLY C. EPSTEINSHANA E . SCARLETT
MARIA V . MORRI S100 Pine Street, Suite 2600San Francisco , CA 94111
Telephone : 415/288-4545415/288-4534 (fax)
LERACH COUGHLIN STOIA GELLERRUDMAN & ROBBINS LLP
WILLIAM S . LERACHDARREN J . ROBBINS401 B Street, Suite 1700
San Diego, CA 92101Telephone: 619/231-1058619/231-7423 (fax)
Lead Counsel for Plaintiffs
JOHN T. DECARLO, ESQ .DANIEL M. SHANLEY, ESQ .
DECARLO & CONNO R533 South Fremont Avenue , 9th FloorLos Angeles, CA 9007 1Telephone : 213/488-4100213/488-4180 (fax)
AARON D. KRAKOW, ESQ .KRAKOW, SOURIS & BIRMINGHAM, LLC225 Friend StreetBoston, MA 02114Telephone: 617/723-8440617/723-8443 (fax)
Additional Counsel for Plaintiff MassachusettsState Carpenters Pension Fund
T :\CasesSF\Flowserve\CPT00018268 .doc
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CERTIFICATE OF SERVICE
I hereby certify that the foregoing document was served on Noel Hensley at Haynes and
Boone, LLP by hand delivery and all other counsel of record by facsimile on February 15, 2005 .
Willie C . Briscoe