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IN THE UNITED STATES DISTRICT COURT FOR TIIE NORTHERN DISTRICT OF GEORGIA ATLANTA DIVISION
Civil Action No. 1:07-cv-2298
IN RE NETBANK, INC. SECURITIES LITIGATION
Complaint - Class Action Jury Trial Demanded
CONSOLIDATED AND AMENDED CLASS ACTION COMPLAINT
Lead Plaintiff Robert A. Brown ("Plaintiff' or "Lead Plaintiff'), by and through his undersigned attorneys, individually and on behalf of all other persons similarly situated who purchased or acquired NetBank, Inc. ("NetBank" or the "Company") common stock during the period March 16, 2005 through and including May 21, 2007 (the "Class Period") and were damaged thereby, as and for his Amended and Consolidated Class Action Complaint (or "Amended Complaint"), alleges as follows:
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TABLE OF CONTENTS 1.
NATURE AND GENERAL OVERVIEW OF THE CLAIMS .......... 4
II.
BASIS OF ALLEGATIONS .................................... 10
III.
JURISDICTION AND VENUE ................................. I I
IV.
NETBANK, INC. - THE BANKRUPT CORPORATE ENTITY ....... 12
V.
THE PARTIES .............................................. 18
VI.
OTHER RELEVANT PERSONS AND ENTITIES .................. 23
VII.
CLASS ACTION ALLEGATIONS .............................. 33
VIII. ADDITIONAL SUBSTANTIVE ALLEGATIONS .................. 37
IX.
A.
Corporate History of NetBank ............................. 37
B.
NetBank' s Business Segments ............................. 38
C.
Overview of Bank Mortgage Lending ....................... 41
DEFENDANTS' ADDITIONAL FALSE AND MISLEADING STATEMENTS ................................. 44 A.
NetBank's Surreptitious Transition From Its Core Banking Operations to the Subprime Mortgage Market ................. 44
B.
Defendants ' Sham Restructuring of NetBank ................. 74
C.
Defendants Falsely Assure Investors That They Can Rely on NetBank's Book Value ........................ 86
D.
Defendants Make Additional False Assurances
to Investors After E&Y Resigns ............................ 90
-2-
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E.
NetBank Continues to Falsely Reassure Investors About the Company's Condition and Operations ............. 104
F.
NetBank Misleads Investors Regarding the Validity
of Its FAS 133 Accounting ............................... 115 X.
THE TRUTH REGARDING DEFENDANTS' FRAUD BEGINS TO EMERGE ....................................... 123
XI.
GAAP VIOLATIONS ........................................ 139
XII.
A.
Lack of Adequate Internal Controls ..... ................... 142
B.
Understatement of Representations and Warranties Liability .... 162
C.
Undisclosed Impairment of Goodwill ...................... 175
D.
Overstatement of Mortgage Servicing Rights Valuation ........ 182
F.
Ineffective Disclosure of Controls and Procedures ............ 186
ADDITIONAL SCIENTER ALLEGATIONS ..................... 189
XIII. LOSS CAUSATION/ECONOMIC LOSS ........................ 191 XIV. FRAUD ON THE MARKET DOCTRINE ........................ 196 XV.
INAPPLICABILITY OF SAFE HARBOR ....................... 199
CLAIMS FOR RELIEF: COUNT I - Violation of Section 10(b) of the Exchange Act and SEC Rule 10b - 5 Against All Defendants ........ ....... 200 COUNT II - Violation of Section 20(a) of the Exchange Act Against the Individual Defendants .................... 205 PRAYER FOR RELIEF AND JURY DEMAND ........................ 206
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1.
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NATURE AND GENERAL OVERVIEW OF THE CLAIMS
1.
This is a federal securities law class action brought against NetBank's
senior officers and directors, including Douglas K. Freeman, James P. Gross, Steven
F. Herbert, Thomas H. Muller, Jr., Eula L. Adams, David W. Johnson, Jr., and Catherine A. Ghiglieri (collectively, the "Defendants"). 2.
During the Class Period, Defendants engaged in a fraudulent scheme to
artificially inflate the price of NetBank's publicly-traded common stock, in violation
of the federal securities laws, §§ 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule I Ob-5 promulgated thereunder.
3.
Plaintiff alleges, in sum, that Defendants defrauded Class members by
making materially false and misleading statements and omissions regarding the
financial results, operations and condition ofthe Company, which artificially inflated the price of NetBank common stock during the Class Period. As a result of those
statements and omissions, the Company's stock traded at artificially inflated levels during the Class Period -- trading as high as $8.74 per share on March 16, 2005. However, by the end of the Class Period, the Company's stock had evaporated to a mere $0.59 per share on May 21, 2007. 4.
As the Country's oldest internet bank, NetBank claimed early successes -4-
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in supposedly being transformed following its 2001 acquisition of Market Street Mortgage Corporation, and its conservative line of residential mortgages. Shortly
thereafter, NetBank changed its conservative course when in 2002 it acquired Resource Bancshares Mortgage Group ("RBMG"), and that entity's risky subprime
mortgage subsidiary, Meritage Mortgage Corporation. In connection with that acquisition , RBMG's Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), defendants Freeman and Herbert, assumed those same roles with the "new" NetBank, ousting NetBank's more conservative CEO, D.R. Grimes. 5.
At that time ofthe 2002 RBMG acquisition, NetBank's banking business
was only marginally pro f table. In a desperate and reckless effort to grow at all costs, Defendants moved to then essentially transform NetBank into a high risk mortgage
company -- thereby abandoning the conservative mortgages favored by former CEO Grimes and instead relying and expanding upon subprime and other risky mortgage
lending as the primary means of generating income from the Company's $2 billion bank deposit base. 6.
As a result, defendants Freeman and Herbert -- NetBank's "new"
management -- created a corporate culture that blindly focused its emphasis on earnings growth and at least creating the impression that its products and services -5-
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were revolutionary. In executing a plan to reinvent NetBank, Defendants essentially attempted to leverage the Company's deposits with inherently risky subprime loans
and other business segments, in order to create the false impression that the Company's efforts to diversify and capitalize on its banking deposits were successful.
7.
In doing so, Defendants implemented a series ofpolicies, procedures and
practices that failed to comply with Generally Accepted Accounting Principles ("GAAP"), and thereby falsely portrayed the Company ' s earnings, overvalued its mortgage assets, undervalued its subprirne exposures and misaccounted for its hedging activities. NetBank's resulting misrepresentations and omissions were made
by, approved by and/or implemented by each of the Defendants, who include the Company's senior operational officers and its Audit Committee. 8.
Beginning in March 2005, NetBank filed with the United States
Securities and Exchange Commission ("SEC") the Company's 2004 Form 10-K,
which falsely reported not only the Company's financial results, but also its business operations and corporate restructuring. Thereafter, Defendants made continuing misstatements and omissions to the investing public, in which they claimed that the
Company was successfully restructuring and reporting properly its financial results and condition. -6-
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9.
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In May 2006, Defendants made a series of representations to the
investing public in which they claimed that NetBank was then successfully restructuring its operations to eliminate high-risk non-conforming loan origination operations and other failing business segments. These representations were highly
material and impacted the perceived value of NetBank's common stock, because the Company also claimed that it had a strong core banking business that would substantially benefit from the elimination of the high-risk, non-conforming loan origination segment . The Defendants claimed that the restructuring was substantially complete by February 2007. At that time, Defendants also represented that investors
could rely on the book value of the Company as an accurate reflection of NetBank's true value. Those representations were false. 10.
On November 9, 2006, NetBank revealed that its outside auditor, Ernst
& Young (or "E&Y"), would be resigning after the Company filed its Form 10-Q for
3Q2006, which was then made on November 9, 2006. Although this information was not previously made public, Defendants had known this since October 10, 2006. Moreover, the Company and E&Y falsely claimed that no material disputes led to the resignation . On February 16, 2007, NetBank announced that the Company had retained a new outside auditor. Defendants falsely assured investors by stating that -7-
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the filing of its 2006 annual report on Form l 0-K would simply be delayed as a result of this transition. 11.
On May 21, 2007, NetBank shocked the market when. it announced that,
contrary to its prior public representations, its core banking business was in fact highly deficient and that the Company had failed to meet its regulatory capital
requirements. Netl3ank further disclosed that, as a result of this significant deficiency in its core banking business, banking regulators were forcing the Company to consummate a sale of its $2.5 billion of core and brokered deposits, its held for investment loan portfolio, all of the assets and liabilities of NetBank Business Finance, the Company' s small business equipment leasing and financing operation,
and the NetBank brand and related trademarks and service marks. NetBank reported that the forced sell-off would result in a loss of $60-70 million . In. other words, NetBank was being forced to liquidate at a loss its core banking operations and nearly
all of the remainder of its business segments. These disclosures were effectively admissions that the Company's books and valuations were grossly overstated and misstated, and that not only had NetBank failed to account properly for its mortgage business but that even its "core" banking business was on the verge of collapse. Unsurprisingly, as a result of these devastating disclosures, the Company's common -8-
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stock price plummeted 66%, from $1.75 per share on May 18, 2007 to $0.59 per
share on May 21, 2007. 12.
Thereafter, on August 6, 2007, NetBank filed a Form 8-K with the SEC
that reported that the entire carrying amount of goodwill for the Company's whollyowned retail mortgage business, Market Street, would have to be written off, resulting in an impairment charge of $24.6 million. 13.
NetBank then continued to claim that the transition to its new auditor
was delaying the filing of its 2006 Form 10-K, and even its Forms 10-Q for 1 Q2007 and 2Q2007. Indeed, since E&Y resigned in November 2006, NetBank failed to file any of its requisite financial reports with the SEC. As a result, the NASDAQ repeatedly threatened and ultimately did delist NetBank's stock on August 7, 2007.
14,
On August 10, 2007, NetBank filed a Form 12b-25 which reported that
E&Y had withdrawn its audit opinions for the Company's prior Forms 10-K for 2004 and 2005, based on the Company's misapplication of Statement of Financial
Accounting Standard ("FAS" or "SFAS") 133, and that investors should no longer rely on NetBank's financials. The Company also admitted that it had withheld the fact that the SEC had been investigating the Company' s accounting practices since at least August 31, 200 6 -- nearly one year prior. Not only did Defendants fail to disclose -9-
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publicly the SEC investigation, Defendants also failed to disclose that they were unable or unwilling to correct NetBank's accounting and produce accurate financial reports. 15.
Ultimately, Defendants failed to file publicly with the SEC any financial
statements following the 3Q2006 results the Company filed in November 2006. In an effort to conceal their fraud, Defendants also withheld making any financial restatement for its prior financial results -- and allowed instead for the Company's stock to be delisted, and for the Office of Thrift Supervision' ("OTS") to finally step in and shut down NetBank's operations on September 28, 2007. By that time, NetBank's common stock was rendered valueless, the Company sought bankruptcy
protection, and NetBank's investors had become fraud victims of the first bank failure infiveyears, the largest bankfailure since] 993 and the largest bank failure in the history of the State of'Geoxgia. Il.
BASIS OF ALLEGATIONS 16.
Plaintiff makes the allegations herein, other than those concerning
himself, based upon the investigation of Plaintiff's counsel. Said investigation ' The OTS is the primary federal regulator of federally chartered and state-chartered savings associations, their subsidiaries, and their registered savings and loan holding companies. -10-
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included a review of various filings with the SEC, press releases issued by the Company, media reports concerning the Company, publicly disseminated documents concerning the Company's business practices, securities analysts' reports and
advisories about the Company, pleadings and other documents filed in other litigations involving NetBank, and certain other public filings and documents, as well as interviews with former employees of NetBank (some of whom are referenced herein as confidential witnesses). Moreover, the Company has admitted to certain of
the wrongful acts and practices alleged herein; those admissions also serve as a basis for Plaintiff's allegations. Plaintiff believes that additional evidentiary support will exist for his allegations after he is afforded a reasonable opportunity for discovery.
III.
JURISDICTION AND VENUE 17.
This Court has jurisdiction over the subject natter of this action pursuant
to Section 27 of the Exchange Act (15 U.S.C. § 78aa) and 28 U.S.C. § 1331. The claims asserted herein arise under sections 10(b) and 20(a) of the Exchange Act, §
78j(b) and 78t(a), and SEC Rule lOb-5, 17 C.F.R. § 240.1Ob-5. 18.
Venue is proper in this District pursuant to Section 27 of the Exchange
Act (15 U.S.C. § 78aa) and 28 U.S.C. § 1391(b) and (c). Many of the acts and transactions giving rise to the violations of law complained of herein, including the -11-
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preparation and dissemination to the investing public of materially false and misleading information, occurred within this District, and NetBank maintained its principal place of business in Alpharetta, Georgia. 19.
In connection with the acts, omissions, conduct and other wrongs alleged
in this Amended Complaint, all. ofthe defendants, directly and/or indirectly, used the
means and instrumentalities of interstate commerce including the mail, the Internet, interstate telephone cormnunications, and the facilities of national securities markets and exchanges. IV.
NETBANK , INC. - THE BANKRUPT CORPORATE ENTITY 20.
NetBank, Inc. was incorporated in the state of Georgia and maintained
its executive offices at 1015 Windward Ridge Parkway, Alpharetta, Georgia 30005. a.
NetBank was founded in 1996 and represented itself as a financial
holding company that operated a family of businesses focused primarily on consumer and small business banking. By 2007, at the time of NetBank's demise, the
Company's retail banking franchise, NetBank, FSB, was the nation's oldest active Internet bank serving retail and business customers in all 50 states. b.
In addition to its core banking business, NetBank owned several
subsidiaries including: NetBank, FSB ("NetBank, FSB"), a federal savings bank; -12-
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MG Reinsurance Company ("MG Reinsurance"), a captive reinsurance company; Netlnsurance, Inc. ("Netlnsurance"), a licensed insurance agency; and NB Partners, Inc. ("NB Partners"), a corporation involved in so-called strategic partnering
opportunities. Netbank, FSB owned, during all or part of the Class Period, all of the outstanding common stock of: Market Street Mortgage Corporation ("Market Street"), a retail mortgage company; NetBank Payment Systems, Inc. ("NBPS"), a
provider of ATM and merchant processing services for retail and other non-bank businesses ; Meritage Mortgage Corporation ("Meritage"), a wholesale nonconforming mortgage provider ; and Financial Technologies, One
a provider
of transaction processing services to financial services companies. NetBank, FSB's wholesale mortgage division operated as NetBank Funding Services ("Netbank Funding"); its business financing division operated as "NetBank Business Finance"; its automobile financing division operated as "Dealer Financial Services"; and its
recreational vehicle financing division operated as "Beacon Credit Services." c.
As of February 21, 2007, there were 46,425,000 outstanding
shares of NetBank, Inc. The Company's shares were traded on the National Association of Securities Dealers Automated Quotations ("NASDAQ") securities exchange, an open and efficient market. The Company's stock traded on the -13-
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NASDAQ, from 1997 until its delisting on August 7, 2007, under the symbol "NTBK" d.
NetBarik had been named as a defendant in the initial class actions
captioned Adcock v. iVetBank, Inc., et cxl.,1:07-cv-02298-BBM (N.D. Ga.) and Vahdat v. NetBank, Inc., et cil., 1 :07-cv-026 31. -BBM (N.D. Ga.). Under the Court's Order entered in the instant proceedings on April 21, 2008 (Docket no. 32 ), those actions
and all other such class actions were consolidated. However, since the filing of the Adcock action, NetBank filed for protection under Chapter 11 of the federal
bankruptcy laws. See In re llreiBank, Inc., No. 3:07-bk-04295-JAF (M.D. Fla. Bankr., filed September 28, 2007). In adherence to the automatic stay under the bankruptcy laws (11 U.S.C. § 362(a)), NetBank has not been joined as a defendant in this Amended Complaint. 21.
During the Class Period, NetBank carried out a plan, scheme and course
of conduct which was intended to and, throughout the Class Period, did: (i) deceive the investing public regarding the Company's business, operations, management and
the intrinsic value of NetBank securities; and (ii) cause Plaintiff and other members of the Class to purchase NetBank's securities at artificially inflated prices. In furtherance of this unlawful scheme, plan and course of conduct. -14-
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22.
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NetBank: (a) employed devices, schemes, and artifices to defraud;(b)
made untrue statements of material fact and/or omitted to state material facts necessary to make the statements not misleading; and (c) engaged in acts, practices, and a course of business which operated as a fraud and deceit upon the purchasers of the Company's securities in an effort to maintain artificially high market prices for NetBank's securities in violation of Section 10(b) of the Exchange Act and Rule 1 Ob-
5 promulgated thereunder. 23.
NetBank, individually and in concert with the Defendants, 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, operations and future prospects of the Company as specified herein, 24.
NetBank employed devices, schemes and artifices to defraud, while in
possession of material adverse non-public information and engaged in acts, practices,
and a course of conduct as alleged herein in an effort to assure investors of the Company's value andperformance 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 -15-
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made about the Company and its business operations and future prospects in the light of the circumstances under which they w ere made, not misleading, as set forth more particularly herein, and engaged in transactions, practices and a course of business which operated as a fraud and deceit upon the purchasers of NetBank's securities during the Class Period. 25.
NetBank had actual knowledge of the misrepresentations and omissions
of material facts set forth herein, or acted with reckless disregard for the truth in that
it failed to ascertain and to disclose such facts, even though such facts were available to it . NetBank's material misrepresentations and/or omissions were done knowingly or recklessly and for the purpose and effect of concealing the Company 's operating condition and future business prospects from the investing public and supporting the artificially inflated price of its securities. As demonstrated by NetBank's overstatements and misstatements of the Company's business, operations and
earnings throughout the Class Period, NetBank, if it did not have actual knowledge of the misrepresentations and omissions alleged, was sufficiently reckless in failing to obtain such knowledge by deliberately refraining from taking those steps necessary
to discover whether those statements were false or misleading. 26.
As a result of the dissemination of the materially false and misleading -16-
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information and failure to disclose material facts, as set forth above, the market prices of NetBank's securities were artificially inflated during the Class Period. In ignorance
of the fact that market prices of NetBank's publicly-traded securities were artificially inflated, and relying directly or indirectly on the false and misleading statements made by NetBank, or upon the integrity of the market in which the securities trade,
and/or on the absence of material adverse information that was known to or recklessly disregarded by NetBank but not disclosed in public statements by NetBank during the
Class Period, Plaintiff and the other members of the Class acquired NetBank securities during the Class Period at artificially high prices and were damaged
thereby. 27.
At the time of said misrepresentations and omissions , Plaintiff and other
members of the Class were ignorant of their fal sity, and believed them to be true. had
Plaintiff and the other members of the Class and the marketplace known the truth regarding NetBank' s financial results, which were not disclosed by Defendants, Plaintiff and other members of the Class would not have purchased or otherwise acquired their NetBank securities,. or, if they had acquired such securities during the Class Period, they would not have done so at the artificially inflated prices which they paid. -17-
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28.
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By virtue of the foregoing, NetBank violated Section 10(b) of the
Exchange Act, and Rule IOb-5 promulgated thereunder. As a direct and proximate result of NetBank's wrongful conduct, Plaintiff 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. V.
THE PARTIES A.
The Lead Plaintiff
29.
Lead Plaintiff Robert A. Brown, a citizen and resident of Arizona,
purchased and/or acquired NetBank common stock during the Class Period at artificially inflated prices and was damaged thereby. Attached hereto is a copy of Mr.
Brown's PSLRA certification that was filed previously in this litigation. B.
The Individual Defendants 1.
30.
Steven F . Herbert ("Herbert")
Defendant Herbert was, from the inception of the Class Period through
October 5, 2006, NetBank's Chief Financial Executive ("CFE") and a Director of the Company. From October 5, 2006 through December 17, 2007, Herbert was replaced
Defendant Freeman as NetBank's Chief Executive Officer ("CEO"). Herbert signed the Company's Forms 10-K for the years 2004 and 2005. He also signed Company's -Is-
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Forms 10-Q for the first, second and third fiscal quarters of 2005 (filed with the SEC on May 10, August 9 and November 14, 2005, respectively) and Forms 10-Q for the
first and second fiscal quarters of 2006 (filed with the SEC on May 10 and August 8, 2006, respectively). As to each of the Forms 10-K and 10-Q that Herbert signed, as
well as NctBank's Form 10-Q for the third fiscal quarter of 2006 (filed on November 9, 2006 ), he also signed a Certification Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Amended, and a Certification Pursuant
to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002. Defendant Herbert also signed many of the Company's Forms S-K filed
with the SEC and made numerous public statements to the investing public through various means including, but not limited to, press releases, media interviews and con Terence calls with analysts and investors. 31.
Defendant
Herbert
made
numerous
false
and
misleading
misrepresentations via SEC filings, press releases, and/or similar financial statements
and reports that were disseminated to the investing public. Among other things, Herbert was responsible for NetBank's improper accounting practices in connection
with its non- conforming mortgage loans, as alleged more fully below. As CFE, Herbert was responsible, acting under the supervision of defendant Freeman and the -19-
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Audit Committee, for all financial accounting, financial reporting to investors and regulators and financial statements of NctBank, as well as advising the Board of Directors and senior management . Accordingly, Herbert possessed superior knowledge of and the power to influence and direct the financial accounting, financial
reporting, and financial statements at NetBank. Herbert provided substantial assistance to, participated in, knew of, and/or recklessly disregarded the facts and circumstances of the acts and transactions alleged herein. 32.
Defendant Herbert joined NetBank in 2002 after the Company acquired
RBMG, where Herbert had served as the CFO prior to the acquisition. Herbert has extensive experience in the accounting and financial services industry, having served as the Chief Finance Executive of RBMG for seven years. Prior to joining RBMG,
Herbert managed the 20-person audit practice of Price Waterhouse, LLP in Columbia, South Carolina.. He also worked as Assistant Vice President, Manager of Bank Accounting for South Carolina National Bank. 2.
33.
Douglas K. Freeman ("Freeman")
Defendant Freeman served as NetBank's CEO from April 1, 2002
through October 5, 2006. He became Chairman of its Board of Directors on January 29, 2003 and resigned that position on October 5, 2006. Like Herbert, Freeman joined -20-
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NetBank in 2002 after the Company acquired RBMG, where he served as the CEO. Freeman signed the Company's Forms 10-K for the years 2004 and 2005. He also signed a Certification Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Amended , and a Certification Pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes -Oxley Act of 2002 as to the Company's Forms 10-K for the years 2004 and 2005 and Forms 10-Q for the first, second and third fiscal quarters of 2005 (filed with the SEC on May 10, August 9 and November 14, 2005, respectively) and Forms I0-Q for the first and second fiscal quarters of 2006 (filed with the SEC on May 10 and August 8, 2006, respectively). Defendant Freeman also made numerous public statements to the
investing public through various means including, but not limited to, press releases, media interviews and conference calls with analysts and investors. 34.
Defendant Freeman was responsible for the operations and management
of the Company and possessed the power and authority to control both the Board and the officers and other executives of NetBank. Accordingly, Freeman possessed the
power to, and did in fact, direct the acts and transactions of the Company and the acts of its officers and directors , including, but not limited to, the Company's accounting practices and financial reporting. Defendant Freeman provided substantial assistance -21-
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to, participated in, knew of, and/or recklessly disregarded the facts and circumstances of the acts and transactions alleged herein. Freeman received a lump-sum payment of $2.9 million as a severance package when he left NetBank in late 2006.
3. 35.
James P. Gross ("Gross")
Defendant Gross was appointed to replace Defendant Herbert as
NetBank's Chief Financial Executive ("CFE"), beginning in October 5, 2006, at
which time he was responsible for all financial operations and reporting for the Company. At the time of his appointment as CFE of NetBank, Gross had served as
the Company's Controller since January 2004. From 2002 to 2004, he served as the Company's Director of Financial Planning and Reporting . As CFE, Gross signed the Company's Form 10-Q for the third quarter of 2006. He also signed a Certification
Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Amended, and a Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 to the Company's Form 10-Q for the third quarter of 2006. Defendant Gross also signed many of the Company ' s Forms 8 -K filed with the SEC and made numerous public
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As CFE of NetBank , Gross possessed the power to, and did in fact,
control and direct the acts and transactions of NetBank and the acts of NetBank's officers as they related to the Company's application of accounting methods and financial reporting of the operations of NetBank. Gross provided substantial
assistance to, participated in, knew of, and/or recklessly disregarded the facts and circumstances of the acts and transactions regarding NetBank beginning as alleged
herein. 37.
Prior to joining NetBank in March 2002, Gross served in this same
capacity at RBMG from 2000 through 2002. Prior to joining RBMG, he held executive management positions with several mortgage banking companies, including serving as CFO of IndyMac and J. L Kislak Group. Gross began his career in public
accounting with E&Y, which served as the independent auditors for RBMG and NetBank.
4. 38.
Thomas H. Muller, Jr. ("Muller")
Defendant Muller was named Chairman ofNetBank on October 5, 2006,
replacing T. Steven Johnson. He served on the Company's Board and as Chairman of its Audit Committee since its inception. Muller signed the Company's Forms 10-K for the years 2004 and 2005. -23-
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39.
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Defendant Muller has more than 30 years of experience in financial
management. lie is currently president of Muller & Associates, a business operations and financial management company. As the former CFO of SpectRx, Inc., he oversaw that company's financial operations as well as personnel, administrative and legal
activities . His previous experience also includes serving as CFO for HBO & Company and Coca-Cola USA. 5.
40.
Eula L. Adams ("Adams")
Defendant Adams served as a Director of NetBank during the period
from July 2003 until his resignation which was effective as of September 28, 2007. As a Board member, Adams served as a member of the Audit Committee and Corporate Governance Committee. In his capacity as a Director of NetBank, Adams
signed the Company's Forms 10-K for the years 2004 and 2005. 41.
Defendant
Adams
is
the
Vice
President,
Data
Management,
Group/Services Delivery, for Sun Microsystems, Inc. He has more than 30 years of
experience in financial services and accounting . Adams has also served as Vice President, Global Services for StorageTekbefore its acquisition by Sun Microsystems in August 2005. Previous to that, Adams spent 18 years with Deloitte & Touche where he became a partner and served in various positions. -24-
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6. 42.
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David W. Johnson , Jr. "Johnson"
Defendant Johnson served as a Director ofNetBank from the Company's
inception in 1996, and also served as a member of the Board's Audit Committee until his resignation from the Board in May 2005. In October 2006, Johnson was elevated to Vice Chairman of the Company. Johnson signed the Company's Forms 10-K for
the years 2004 and 2005. 43.
Defendant Johnson has more than 30 years of experience in mortgage
banking. Johnson served in various capacities with RBMG for eight years, including chief operating officer, president, chief executive officer, vice chairman and -managing director. Prior to joining RBMG, he was with Bear, Stearns & Co. Inc. and
with Bankers Mortgage Corporation. 7. 44.
Catherine A. Ghiglieri ("Ghiglieri")
Defendant Ghiglieri served as a Director of NetBank from December
2003 until she resigned on September 20, 2005. During that period, Ghiglieri served as a member of the Board's Audit Committee. In her capacity as a Director of NetBank, Ghiglieri signed the Company's Form 10-K for the years 2004. 45.
Defendant Ghiglieri was the president of Ghiglieri & Company, a
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career. Ghiglieri served as Texas Banking Commissioner for seven years and was responsible for the supervision of the third largest state banking system in the United States. Prior to that, she spent 18 years in various positions of responsibility with the
Office of the Comptroller of the Currency. 46.
Defendants Freeman, Gross, Herbert, Muller, Adams, Johnson, and
Ghiglieri are collectively referred to herein as the "Individual Defendants." 47.
As a result of their positions with the Company , each of the individual
Defendants had access to the adverse non-public information about the Company's true financial results, operations and condition, and each had access to internal, nonpublic corporate documents, conversations and connections with other corporate officers and employees, attendance at management and/or Board of Directors'
meetings and committees thereof, and reports and other information provided to them in connection therewith. Because of their positions with the Company, all of the
Individual Defendants controlled and/or possessed the power and authority to control the contents of the Company's SEC filings , press releases , and presentations to securities analysts, through which information was conveyed to the analysts and then to the investing public. Each of the Individual Defendants was responsible and obligated to ensure the accuracy of the Company's SEC filings, reports, and press -26-
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releases alleged herein to be misleading , and each had the ability and opportunity to prevent their issuance if they were inaccurate or to promptly correct same.
48.
Because of their positions and access to material non-public information
available to them, each of the Individual Defendants either knew or recklessly disregarded that the Company's SEC filings, press releases, and presentations to
securities analysts contained material misstatements and omissions. Each of the Individual Defendants is, therefore, liable formaking or participating in making such
material misstatements and omissions regarding the true state of the Company's financial results, operations and condition. 49.
Defendants Muller, Adams, Johnson, and Ghiglieri each served as
members of the Audit Committee of NetBank's Board of Directors at various times during the Class Period. 50.
The Charter of the Audit Committee of the NetBank Board of Directors
stated, in part, that: The Audit Committee's purpose is to oversee the Company's accounting and financial reporting processes and the audit of its financial statements. The Committee shall provide assistance to the corporate directors in fulfilling their responsibility to the shareholders, potential shareholders, and investment community relating to corporate accounting, reporting practices of the corporation, and the quality and integrity of the financial reports of the corporation. In so doing, it is the -27-
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responsibility of the Audit Committee to maintain free and open means of communication between the directors, the independent auditors, the internal auditors, and the financial management of the corporation. The Audit Committee's performance and composition will at all times be subject to, and in compliance with: (i) Section 1OA of the Securities Exchange Act of 1934 and the rules promulgated thereunder; and (ii) regulations promulgated by any stock exchange upon which the Company's securities are traded. 51.
The Individual Defendants are liable as direct participants in the wrongs
complained of herein. In addition, the Individual Defendants, by reason oftheir status as senior executive officers and/or directors, were "controlling persons" within the meaning of §20(a) of the Exchange Act and had the power and influence to cause the
Company to engage in the unlawful conduct complained of herein. Because of their positions of control, the Individual Defendants were able to and did, directly or indirectly, control the conduct of NetBank's business and operations.
VI.
OTHER RELEVANT PERSONS AND ENTITIES A.
Ernst & Youn LLP - NetBank' s Indep endent Auditor
52.
Ernst & Young LLP ("E&Y") was, at all relevant times, the outside
accountant and auditor for NetBank. E&Y served as NetBank's independent public
accountants and auditors from 2002, having replaced Deloitte & Touche LLP as the Company' s auditors . During the Class Period E&Y's NetBank engagement was
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headed by Engagement Partner Konstantin Grobovsky and Senior Auditor Nick. Seina. E&Y continued to served as NetBank's outside accountant and auditor until. its resignation on October 10, 2006, when it was eventually replaced by Porter Keadl e Moore, LLP. 53.
E&Y is a "Big 4" public accounting firm with offices throughout the
United States, including Atlanta, Georgia. E&Y was engaged to examine, audit, and provide opinions on NetBank ' s financial statements for the years 2002, 2003, 2004
and 20 0 5. Specifically , E&Y audited NetBank's financial statements for, among others, each of the fiscal years ended December 3 1, 2004 and 2005, issued unqualified audit reports on those financial statements, and consented to the inclusion of those unqualified audit reports in E&Y's Forms 10-K for those periods. E&Y's unqualified audit reports on those financial statements were dated March It, 2005
and March 13, 2006, and addressed to the Board of Directors and Shareholders of NetBank. However, those reports specifically provided that:
These financial statements are the responsibility of NetBank, Inc.'s management . Our responsibility is to express an opinion on these financial statements based on our audits.
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Non-Party Directors of NetBank 1.
54.
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J. Stephen Heard
J. Stephen Heard served as a Director of NetBank during the Class
Period. In his capacity as a director of NetBank, Heard signed the Company's Forms
10-K for the years 2004 and 2005. Heard is president of Heard Systems, Inc., a provider of point-of-use systems and information systems consulting services. Ile worked for IBM for approximately 30 years and later served as product sales
executive, Vanstar Corporation and area vice president, Hartford Computer Group. 2. 55.
Joel A. Smith, III
Joel A. Smith, IIi, served as a Director of NetBank during the Class
Period. In his capacity as a director of NetBank, Smith signed the Company's Forms 10-K for the years 2004 and 2005. Smith has over 30 years of experience in banking. After retiring from Bank of America in 2000, he became Dean of the Moore School of Business at the University of South Carolina. Smith joined Bank of America in 1971 and eventually served as the president of Bank of America East with
responsibilities for commercial, small business, premier and consumer banking divisions.
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3.
56.
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Robin C. Kelton
Robin C. Kelton served as a Director of NetBank during the Class
Period. In his capacity as a director ofNetBank, Kelton signed the Company's Forms 10-K for the years 2004 and 2005. Kelton is Chairman and Chief Executive Officer of Kelton International Ltd., an investment banking firm formed in January 1.996 specializing in the banking and insurance industries. He is founder and former Chairman and Chief Executive Officer of the Fox-Pitt, Kelton Group and Fox-Pitt, Kelton, Inc. In addition, he is Chairman of Thomas Murray Limited, a financial services company, Chairman ofFindlay Park Investment Management Ltd. and Eagle & Dominion Asset Management Ltd., both fund management companies, and
executive Chairman ofFinancial Centre Corporation, the St. Lucia offshore financial centre.
4. 57.
Stuart M. Cable
Stuart M. Cable served as a Director ofNetBank during the Class Period.
In his capacity as a director ofNetBank, Cable signed the Company's Forms 10-K for the years 2004 and 2005. Cable is an attorney with Goodwin Procter LLP. He served as a director of Resource Bancshares Mortgage Group, Inc. ("RBMG") from 1992 until its merger with NetBank on March 31, 2002, at which time he became a director
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of the Company. 5.
58.
Tamara L. Adler
Tamara L. Alder Lundgren served as a Director of NetBank throughout
the Class Period, beginning in December 2003. In her capacity as a director of
NetBank, Lundgren signed the Company's Forms 10-K for the years 2004 and 2005. Adler is a senior finance professional and lawyer with more than 20 years of structured finance, corporate and real estate experience. She also served as the managing director and head of the Structured Finance group within Debt Capital Markets at JP Morgan Chase. Prior to joining JP Morgan, she served as the managing director and head of Deutsche Bank's European Securitization Group where she was also a member of Deutsche Bank's Global Markets Management Committee. Adler
was also a partner at Hogan & Hartson, LLP in Washington, D.C. 6. 59.
T. Stephen Johnson
T. Stephen Johnson served as the Chairman of NetBank's Board from
the Company' s inception through early 2003 and, thereafter, continued to serve on the Company's Board through the Class Period. In his capacity as a director of
NetBank, Johnson signed the Company's Forms 10-K for the years 2004 and 2005. Johnson was President of Johnson & Associates ("TSJ&A"), a bank consulting firm -32-
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located in Alpharetta, Georgia. The firm specialized in mergers, acquisitions and
regulatory consulting . TSJ&A has served as advisor and consultant in the formation of approximately 70 banks in the southeastern United States. Mr. Johnson served in a management capacity for two large Atlanta banks before forming TSJ&A in 1987.
Mr. Johnson also serves as Vice Chairman of Florida Banks, Inc., a bank holding company, Chairman of Direct Payment Technologies, Inc., a card payment and
processing company, and Chairman of Brightlane.com, Inc., a business-to-business portal. In addition, he is principal owner of Bank Assets Inc., a provider of benefit programs for directors and officers of banks, and TSJ Advisory Group, an investment
advisory company. VU. CLASS ACTION ALLEGATIONS 60.
Plaintiff brings this action individually and as a class action pursuant to
Rule 23(a) and 23(b)(3) of the Federal Rules of Civil Procedure on behalf all persons who, during the Class Period, March 16, 2005 through and including May 21, 2007, purchased or otherwise acquired any securities publicly issued by NetBank, Inc., including without limitation NetBank common stock, and held such securities as of May 21, 2007, and where damaged thereby (the "Class"). Excluded from the Class are the Defendants herein, members of the Individual Defendants' immediate -33-
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families, any entity in which any of the Defendants has or had a controlling interest, any person or entity affiliated with any of the Defendants, and the legal representatives, heirs, successors or assigns of any of the Defendants. 61.
This action is properly maintainable as a class action because:
(a)
The Class is so numerous that joinder of all members is
impracticable. According to the Company's Form 10-K for year ended 2005, as filed
with the SEC on March 15, 2006, NetBank had 46,586,415 shares of its common stock issued and outstanding as of March 6, 2006. During the Class Period, NetBank's common stock was listed and actively traded on the NASDAQ, a national securities exchange and an efficient market, and a liquid market for NetBank common stock. While the exact number of Class members is presently unknown and can only be ascertained through appropriate discovery, Plaintiff believes that there are many hundreds, possibly thousands, of Class members located throughout the United States who similarly purchased or otherwise acquired NetBank securities during the Class Period. (b)
Plaintiff's claims are typical of the claims of the other members
ofthe Class. Plaintiff and the other members ofthe Class have sustained damages that arise from, and were caused by, Defendants' wrongful acts alleged herein. Plaintiff -34-
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does not have interests antagonistic to, or in conflict with, the other members of the Class; (c)
Plaintiff is a representative party who will fairly and adequately
protect the interests of the other members of the Class and has retained counsel competent and experienced in class action securities litigation; (d)
A class action is superior to other available methods for the fair
and efficient adjudication of the claims asserted herein, because joinder of all members is impracticable. Furthermore, because the damages suffered by individual Class members may be relatively small, the expense and burden of individual litigation make it virtually impossible for Class members to individually redress the wrongs done to them. The likelihood of individual Class members prosecuting separate claims is remote;
(e)
Plaintiff anticipates no unusual difficulties in the management of
this action as a class action; and (f)
Common questions of law and fact predominate over any
questions affecting any individual members of the Class. 62.
Among the common questions of law and fact are: (a)
Whether the federal securities laws were violated by Defendants' -35-
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acts and omissions as alleged herein; (b)
Whether the documents , press releases, financial reports and
statements disseminated by the Defendants to the investing public during the Class Period misrepresented or omitted material facts about the financial results, operations and condition of NetBank.; (c)
Whether NetBank's publicly disseminated financial statements
and reports were materially false and misleading as alleged herein; (d)
Whether Defendants acted with knowledge or with sufficient
reckless disregard for the truth in misrepresenting and/or omitting to state material facts; (e)
Whether, during the Class Period, the market price of Net 3ank's
common stock was artificially inflated due to the omissions and/or material misrepresentations complained of herein; (t)
Whether Defendants participated in and. pursued the common
course of conduct complained of herein; (g)
Whether the Individual Defendants were "control persons" within
the meaning of Section 20(a) of the Exchange Act; and (h)
Whether the members of the Class have sustained damages and, -36-
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if so, what is the extent of such damages. VIII. ADDITIONAL SUBSTANTIVE ALLEGATIONS A.
Corporate History of NetBank
63.
NetBank was founded in October 1996 when it received its federal
banking charter. That same month, NetBank completed its initial public offering of stock for $12 a share, under the name NetB@a nk Inc. At the time, the Company claimed its operating expenses were half those of a traditional "bricks-and-mortar" hank, and that it could thus offer customers higher rates on checking accounts and certificates of deposit. When the Company began its Internet banking operations, NetBank was one of the pioneers of the Internet banking industry, and its subsidiary,
NetBank., FSB, was recognized as one of the first successful internet-only banks. At that time, NctBank's touted value proposition and product line was differentiated in the marketplace, since few direct competitors existed. The Company claimed that its
products and services were designed to serve a growing base of computer-savvy consumers who were seeking both convenience and greater economic value. 64.
Over time, NetBank essentially evolved into a financial holding
company, but claimed it was still engaged primarily in retail banking. NetBank's additional business segments grew to include mortgage banking, business finance, -37-
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insurance and providing ATM and merchant processing services . See generally Section IV, supra.
B.
NetBank' s Business Segments
65.
Prior to its demise in 2007, Netbank's business consisted primarily of
three segments: retail banking, transaction processing, and services as a financial
intermediary. 66.
Retail Banking. Retail banking was NetBank's core business segment
from its inception . As the Company' s operations expanded into transaction processing and financial intermediary services, NetBank insisted that retail banking
would remain its core business. NetBank's retail banking segment was comprised of personal and small business banking operations, an automobile financing unit and a business financing unit. NetBank, FSB, through its Internet banking operations,
operated as an Federal Deposit Insurance Corporation ("FDIC ") insured, federally chartered thrift institution. NetBank, FSB offered a full line of deposit and loan products, including checking and savings accounts, a small business banking program, online bill payment, auto loans, and financial planning services. As such, NetBank, FSB served approximately 285,669 customers throughout the United States and in more than 90 foreign countries. NetBank, FSB delivered its products and -_8-
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services through remote delivery channels, such as the Internet, telephone and ATMs, that were available 24 hours a day and seven days a week. NetBank, FSB did not maintain a branch network to support its banking business. This branchless model provided it with an opportunity to operate with less overhead expense than traditional
branch banks; however, it also presented numerous challenges not faced by traditional branch based banks. Indeed, passing along part of the potential cost savings to
customers through higher deposit rates and better technology had been the cornerstone of NetBank's supposed value proposition. 67.
Transaction Processing . The transaction processing segment included
NetBank's ATM and merchant processing business, mortgage servicing division and a number of start-up operations that delivered banking or item clearing functionality
to other financial institutions or merchants. NetBank established this segment in 2003 when it began restructuring the Company in attempting to leverage many of the core business competencies in its retail banking and financial intermediary segments, and
market them on a business-to-business basis. Those action were supposed to provide the Company with additional revenue generating opportunities from then existing
business activity. This shift in focus was motivated by the fact that NetBank's core banking business was not as strong as it had been portrayed, and the viability of -39-
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NetBank's business over the long-term was at particular risk if the Company did not seek and obtain additional sources of revenue outside of its core banking business. Through its transaction processing segment, NetBank had also been an active acquirer
of small, profitable processing businesses that, when properly executed, should have supposedly complemented its overall business strategy. For example, in late 2003, NetBank acquired an ATM and merchant transaction processing operation , including the subsidiary known as FTY. During 2004 and 2005, the ATM and merchant transaction processing operation grew through acquisitions and internal growth. At its height, the business operated at least 9,649 ATMs across the United States. At the time, NetBank ' s network of ATMs ranked as the second largest bank-operated ATM.
network in the country. 68.
Financial Intermediary . The financial intermediary segment included
NetBank's mortgage and specialty lending operations. Through the segment's various
loan operations, NetBank served as an intermediary between consumers and institutional investors. The Company diversified its operations through acquisition to include the origination of loans for recreational vehicles (RVs), boats and personal aircraft . The Company earned fees on the loans it originated and had the opportunity to earn a profit on the sale of the mortgage loans or mortgage backed securities which -40-
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consisted of portfolios of multiple loans packaged into an investment vehicle. The loans were either retained by the retail banking segment to meet the Bank's investment needs or sold to investors in the capital markets under the same intermediary strategy the Company employed in its mortgage businesses. The bulk of the business in this segment related to mortgage lending, and included both so-
called conforming and non-conforming products. C.
Overview of Bank Mortgage Lending
69.
Mortgage loans fall into two broad categories: conforming and non-
conforming. 70.
Conforming Mortgage Loans: Conforming mortgages are mortgages
that have terms and conditions that follow the guidelines and standards set forth by the Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan Mortgage Corporation ("Freddie Mac"), two stockholder-owned corporations. Fannie Mae and Freddie Mac guidelines establish the maximum loan amount, borrower
credit and income requirements, down payment, and suitable properties. Fannie Mae and Freddie Mac announce new loan limits every year. Fannie Mae and Freddie Mac
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are then typically packaged into securities and sold to investors. Because these "conforming" mortgages must comply with Fannie Mae and Freddie Mac guidelines,
they are understood to be safer investments that involve less risk than nonconforming mortgages. Through this process, Fannie Mae and Freddie Mac, like the Government National Mortgage Association ("Ginnie Mae"), provide a continuous
flow of affordable funds for home financing that results in the availability of mortgage credit for American home buyers. 71.
Non - Conforming Loans : A nonconforming mortgage is a loan that
fails to meet certain bank criteria for funding. Such a loan may fail to conform to the bank's lending criteria because, for example, the loan amount is higher than the
conforming loan limit. A substantial portion of real-estate loans are qualified as nonconforming because either the borrower's financial status or the property type does not meet bank guidelines. Non-conforming loans can be either A-rated paper (less
risky) or subprirne loans (more risky). Subprime lending carries increased risk for both lenders and borrowers due to the combination of high interest rates, poor borrower credit history, and the questionable financial circumstances often associated with subprime applicants. Due to the increased risk, subprime loans are offered at an interest rate higher than A-paper loans. -42-
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72.
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Mortgage originators "package" large volumes of home loans to be used
as collateral in massive mortgage-backed security ("MBS") offerings (also known as collateralized debt obligations or CDOs) to investors such as ledge funds, allowing the originators to further finance their activities.
73.
During the course of the 1990s and early 2000s, as the housing market
in the United States increased substantially in strength, many lending institutions
were willing to provide mortgages to low credit high risk borrowers relying on the increased value of the housing markets to provide protection against default. These mortgages were then packaged for sale to investors. 74.
In early 2006, as the housing market began to weaken, two trends in the
secondary market for subprime mortgages emerged: (1) sales of home equity loans for borrowers with the weakest credit and the smallest cash down payments produced
sizable discounts as investors took into account the end of rapid home price appreciation as a safety net for such borrowers, as well as other credit concerns; however, lender pricing did not take these into account; and (2) forced repurchases of subprime loans experiencing delinquencies early in their lives began to rise. Such forced repurchases, reflect both a spike in "early payment defaults" and more aggressive enforcement of related contractual clauses by the investors, especially -43-
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Wall Street conduits. IX.
DEFENDANTS' ADDITIONAL FALSE AND MISLEADING STATEMENTS A.
NetBank's Surreptitious Transition From Its Core Banking Operations to the Subprime Mortgage Market
75.
From its founding in 1996 to 2001, NetBank had grown to become the
Country's largest retail Internet bank. During that period, NetBank went from
approximately 5,000 accounts with $100 million in deposits in 1996, to 245,000 accounts with $1,5 billion in deposits and $2.9 billion in assets as of December 31, 2001. 76.
Beginning at least as early as 2000, NetBank faced two separate
problems. First, although new account growth allegedly remained robust, NetBank knew that the base of depositors the Company relied upon to grow would soon mature
and, as a result, growth would then stagnate . Until that time, NetBank's business model had been fueled solely by such rapid depositor growth in its core banking sector. Second, NetBank knew that its new deposit accounts were substantially and incrementally less profitable to NetBank than its mature accounts. Thus, even if NetBank could continue to rapidly grow its base of depositors, doing so would prove to be a significant drain on the bank's resources and severely hamper profitability --44-
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a fatal flaw to its basic growth strategy.
77.
In an attempt to address these inherent problems with the Company's
business model, NetBank focused its efforts on two areas: (1) developing banking products and services aimed at retaining customers, thereby fostering its more profitable mature customer base, while seeking to actually slow the growth of new accounts; and (2) shifting the Company's founding strategy away from its core banking segment in order to develop other business segments that would leverage its
core banking assets. In making this shift, NetBank set about to begin acquiring one or more mortgage companies. 78.
On June 29, 2001, NetBank acquired Market Street Mortgage
Corporation ("Market Street"). Market Street was a retail mortgage lender based in Clearwater, Florida, which primarily originated fixed first mortgages. In doing so, NetBank made an initi al effort to concentrate on investing in singl e-fam ily residential loans with adjustable rates to manage the interest rate risks. The past due rates on these types of mortgages were approximately one-tenth the industry average which fit the conservative strategy NetBank had pursued up until that time. The Market
Street acquisition enabled NetBank to originate over $3 billion in loans annually. Market Street contributed positively to NetBank's earnings immediately following -45-
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the first quarter after the acquisition, which appeared to validate the Company's new strategy.
79.
In the NetBank's 2001 Form 10-K, filed with the SEC on March 18,
2002, the Company reported the alleged success of its Market Street acquisition as follows: We also diversified and enhanced our income stream through the acquisition of Market Street. This acquisition allowed us to generate fee income related to the origination and sale of first mortgages, to reduce the risk of material write-downs of premiums related to prepayment activity during periods of declining rates, and to participate in the increased refinancing activity during a period of declining rates. 80.
However, in order for NetBank to generate the revenue sought, it was
necessary For the Company to significantly increase its mortgage-lending capabilities. Buoyed by the apparent success o (the Market Street acquisition, NetBank continued its expansion into the mortgage market through the 2002 acquisition of RBMG, a wholesale mortgage banking company headquartered in Columbia, South Carolina.
RBMG had a nationwide network of correspondents and brokers, and generated close to $12 billion in mortgages annually. However, the RBMG acquisition included the
acquisition of RBMG's subsidiary known as Meri.tage, a subprime lender. 81.
As alleged above, defendants Herbert and Freeman were, respectively,
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the CF() and CEO, of Meritage. As a result of NetBank's acquisition of RBMG,
Herbert became the CFF of NetBank and Freeman replaced D.R. Grimes as the Company's CFO. Thereafter, under the direction and control of defendants Herbert and Freeman and the Company's Board of Directors, NetBank surreptitiously shifted
focus from the primarily conservative conforming loans of Market Street and RBMG to Meritage's highly risky subprime loans. 82.
NetBank's 2002 acquisition of RBMG and, in particular, its Meritage
subsidiary , represented a crossroads for the Company's history because it ushered in a new era for the Company during which NetBank was transformed from an Internet
based retail bank, to a financial intermediary to, ultimately, little more than a mortgage bank with a significant presence in the subprime market. 83.
Prior to the RBMG acquisition in 2001, NetBank had little, if any,
exposure to the non-conforming mortgage market. In its 2001 Annual Report, NetBank claimed that the RBMG acquisition "dramatically expands the company's lending ability." In the same Report, NetBank went on to state: NetBank's efficient deposit gathering will provide Market Street Mortgage and RBMG a lower cost source of funds for loans. With the acquisition of RBMG and Market Street Mortgage, NetBank will produce more earning assets than core deposits. We will sell the majority of our loans into the secondary market, and these assets will -47-
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remain on our balance sheet only for the amount of time that it takes to sell them. 84.
Despite N"etBank.'s continuing evolution from an Internet based bank to
a subprime mortgage company, the Defendants attempted to deceive the investing public into believing that it was not a significant subprime lender. For example, on
August 3, 2005, defendants Herbert and Freeman engaged in the following colloquy with an analyst (emphasis added): ANNETTE FRANKIE, ANALYST, FRIEDMAN BILLINGS RAMSEY: *' ** And also, I wanted to ask on the sub-prime originations , how deep do you go into the cycle spectrum on the subprime loans? STEVE HERBERT: Okay. Well, on the sales versus production side, there is nothing unusual there. The volume of production did exceed sales, so we created more value and it was released into the income statement in the current quarter. That is just normal timing in periods in which volumes tend to accelerate, sales tend to lag because of the 30day delay on sales. If you looked at production for April-or March, April, and May, generally I think you'd find that probably lines up fairly well with the level of sales that we did in the second quarter because there's basically a 30-day warehouse lag built into the process. Nothing peculiar going on. Our sub-prime originations, I have to get you the distribution of our FICO scores. It is fairly tight.
We do not do anything that you would call C and D type lending. In general, it's a fairly tight distribution of FICO scores, right around the 640-average level. We do have some very high FICO scores in there is well for some customers that just do not want to do all the paperwork and want to buy big house that does not meet Freddie or Fannie -48-
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guidelines. But I think you are going to find a tight cycle band around 64() that we will be able to show you. DOUG FREEMAN: Annette, this is Doug. We really don't look like a sub prin,te lender. We call it non-conformingfor° a good reason, that we look a lot closure [sic l to a confirming loan than we look to some afthe sections lenders out there. 1. 85.
Operational Shortcomings
In order to decrease the risk of default relating to subprirne non-
conforming mortgages (as well as, in fact, conforming mortgages), it is critical that the lender institute a strong set of internal controls to accurately assess the credit worthiness of each borrower . This is critically important as defendant Freeman admitted to the Atlanta Journal and Constitution on July 27, 2006, during the Class Period, because even if non-conforming loans are not bad, "investors who buy the loans will sell them back if any discrepancy or misrepresentation [by the borrower] is later found in documents associated with those loans." 86.
Indeed, NetBank claimed to have just such a set of strong internal
controls to reduce the risk inherent for its own "non-conforming" loan business. For example, in its Annual Report for the year 2000, NetBank claimed:
The discipline NetBank has in managing assets is second to none. We bring a scientific and mathematical approach to our process. Everything -49-
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is quantified, including all aspects of loan and customer performance, as well as pricing and risk implications. We have developed best-execution models to enable us to optimize our delivery into the secondary markets.
In each phase of this cycle, we rely on rigorous analytics to determine the optimal conditions for selling a loan so that we can manage our risk appropriately while obtaining the highest value possible for our shareholders.
87.
Thereafter, and throughout the Class Period, Defendants continued to
claim that NetBank maintained strong internal controls to reduce the risk associated with its loan business. For example, in the Company's Form 10-K for the year ended 2005, Defendants stated: We have a quality control program to monitor compliance with our established lending and servicing policies and procedures, as well as with applicable laws and regulatory guidelines. We believe that the implementation and enforcement of our comprehensive underwriting criteria and quality control program are significant elements in our efforts to purchase high-quality mortgage loans and servicing rights. Our quality control department examines loans in order to evaluate the loan purchasing function for compliance with underwriting criteria. The quality control department also reviews loan applications for compliance with federal and state lending standards, which may involve re-verifying employment and bank information and obtaining separate credit reports and property appraisals.
88.
Ultimately, such assurances were exposed to be false. Indeed, in closing
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Supervision issued a press release that specifically attributed NetBank's demise in part to "weak underwriting", "poor documentation" and "a lack of proper controls". 89.
In addition , NetBank 's "branchless" bank model, while innovative, was
not without its limitations. One of the most significant disadvantages facing depositors of on-line only banks such as NetBank revolves around physical deposits and withdrawals and ATMs. Since, initially, NetBank had no ATM machines and
never had branches, customers had to rely upon the United States Postal Service to deposit checks and had no means to deposit hard currency. Similarly, account holders could not cash checks or withdraw cash at branches. Rather, in order for a NetBank
account holder to obtain their funds in cash, they were required to use an Automatic Teller Machine ("ATM"). However, because initially NetBank did not own or operate
a network of ATMs, NetBank account holders were forced to use ATMs operated by competing banks and, in most cases , to pay a fee to do so. Additional downsides included deposits that could be lost, damaged or delayed in the mail and could not be tracked without the sender purchasing expensive mail tracking services. 90.
The invention of deposit-taking ATMs coupled with NetBank's
acquisition of a large network of ATMs alleviated some of the limitations of
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in a local ATM, where their check would post and clear very quickly. However, the widespread nature of NetBank's customers made it difficult to have ATMs that were convenient for all customers and many were still required to use mail-in deposits. 91.
NetBank attempted to alleviate the cumbersome and potentially risky
issue of making physical deposits by creating QuickPost, a service whereby a customer drops a deposit off at a UPS Store location to be shipped overnight to NetBank. The concept underlying QuickPost was that one shipment could contain deposits from several customers, justifying the additional expense of overnight
shipping. However, the product did not take off, and NetBank was forced to shut down this operation in 2006. 92.
NetBank heralded the development of QuickPost in its Annual Report
for the year 2004, fled with the SEC March 16, 2005 , stating: For consumers, small business owners and institutions that use NetBank's transaction processing services, our goal is to offer the most needed products and services in the most convenient and versatile setting. To deliver these effectively, we implemented a new online platform and opened a state-of-the-art payment processing center that positioned NetBank to take immediate advantage of legislation authorizing the use of electronic check images. The new processing center also made it possible for NetBank to develop QuickPostSM, a service that allows customers to drop off deposits and payments at approximately 3,800 locations of The UPS Store® for overnight
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delivery and next-day processing.
QuickPost is a service designed to dramatically reduce the time from check drop-off to availability of funds. Through our agreement with UPS, a customer can take a deposit or mortgage payment to one of approximately 3,800 The UPS Store® locations for free overnight shipment to our payment processing center. Customers receive an e-mail acknowledgment when the deposit is received the following business day. This service provides customers greater convenience, security and quicker access to funds.
Initially piloted in Atlanta, Chicago, New York, Oakland and San Francisco, QuickPost is now available to all. NetBank customers.
QuickPost represents one more way NetBank is branching out with innovative services.
93.
According to a confidential witness, who was a NetBank officer
employed in the Corporate Finance Department throughout the Class Period and who
had direct dealings with top management including CFE Herbert, NetBank was aware that QuickPost was an -unsustainable initiative . After implementing QuickPost, NetBank determined that there were an average of 1.2 deposit items in each envelope
they received, and the cost to NetBank for each envelope sent in was between $11.00 and $1.5.00. Therefore, the cost of QuickPost to NetBank far exceeded the incremental value of the deposits and further eroded the limited profits that the
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Company earned from depositors while creating an expectation on their part that NetBank could not readily eliminate without risking further erosion of its depositor base. 94.
During NetBank's August 3, 2005 conference call with analysts and
investors, relating to the second quarter of 2005, the Defendants repeatedly touted Quick Post: We are actively promoting an array of services to other financial institutions, chief among them being Quick Post, our deposit-forwarding services through the UPS stores. A lot of interest has been expressed in this service. Our own Net Bank customers have adopted it in droves. During the second quarter, more than a third of our paper check deposits came in through it.
MATTHEW SHEPHERD : Let me hit the UPS. And I'll let Steve talk about the seasonality and some entries on the servicing side that I think got us above $ 100 million , probably in the fourth quarter i f I'm not mistaken . If you look at the UPS stuff, Rich , we are extremely bullish on that . Our customers have already used 90% of the UPS stores to send paper checks in to our image Check 21 factory . And the system is working unbelievably well . Our customer feedback has been outstanding in the process . As we've said publicly, we are very close to announcing other people who have the same transportation -- paper transportation customer service funds distribution issues that we are , that they are national institutions that lack national bricks and mortar. So they're forced to use our good of postal service or whatever to get their payments and checks in to their company. And they have a great interest in coming on the system . So what you will see is, at some point, when we have added a third party to our mix, we will break Quick Post out in -54-
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our numbers and that to you and show you metrics that will be able to get you there. I cannot tell you, Rich, what quarter that will be, because it needs to be material when we break it out. But I feel extremely good that you're going to see some very attractive announcements that are going to move us in that direction.
MARK SPROULE: Just to shift gears-- thank you for the questions-- on the banking side, you'd mentioned, I think in an earlier question, your continued focus and ability to drive double-digit asset growth and then continue small-business customers. flow are you going about right now attracting those, I mean because we see it on the monthly statistics, you are not seeing significant ramp up monthly as you go, of new customers there. Are you using rates as your driving force? Or is the QuickPost, PowerPost type appeal really the method to act the new customers in and what kind of attraction you are getting? Thanks.
DOUG FREEMAN: The market today, because of our company, we don't have the earning assets that allow us to be purely a rate play. And as a matter of fact, that's never been in our strategy. If somebody wants the hot money, hot, hot, hot money, money market only type of things, they can probably get a better rate from someone who has got some sort of match-to-earning asset that they can deploy that against. And today, we do not have that. So we are extremely competitive from a rate perspective. But we focus on value. So, if you're a retail customer, it's the quality of our technology, it's things like QuickPost and all of that if you're a small business. It's a plethora of services that we offer from convenience to actually on the phone business bankers to work with these people. We have online payroll, we have QuickPost, we have PowerPost and it could go on and on and on. So our strategy has always been to be a super regional bank in terms of how we approach the business, but our region is the Internet. If that make sense to you.
95.
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reported that, "Expenses increased primarily as the result of increase in marketing costs related to specific promotions and on-line advertising campaigns that occurred
during the third quarter of 2005, expansion of Dealer Financial Services' operations, and the roll-out in 2005 of QuickPost, which provides a more convenient way for customers to make deposits to their NetBank accounts."
96.
During NetBank's conference call with investors for the period relating
to the third quarter of 2005, Quick Post was repeatedly touted despite its continuing drag on earnings because, although many customers had utilized the service, it was costing NetBank more money to make the service available than the retained customers were generating for the bank: The feedback we continue to receive from our own customers about Quick Post is overwhelmingly positive. They see it as a very convenient, highly secure method of making deposits and payments.
We continue to view Quick Post as one of the keys to our transaction processing revenue growth. USAA and other partners have the potential to generate significant fee income for us, over time, if their customers adopt this channel to the extent that ours have. Steve will give you more detail on the various points in his review of our performance by business line in a minute.
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relationships. We also benefit from our varied lending operations and the high potential transaction process and initiatives we have underway. The work we're doing on that front with Quick Post and Power Post continue to show great promise. Through relentless execution of our game plan, we will continue to provide superior service to our chosen customer segments and prove the company's core earnings profile and, most importantly, create better value for our shareholders.
JENNIFER DEMBA: Doug, can you give us some sense of what the penetration and the usage is like for the Quick Post right now from your customer base?
DOUG FREEMAN: About 90% of the UPS stores are now in the business of accepting loan payments or deposits and forwarding them to us. So that's unbelievable penetration on the UPS store side. If you look at our customers, what you see is that if you take out direct deposit of payroll, about 30% of the deposits that we get today are coming through Quick Post, and we expect that number, actually, to go up, over time, as we continue our marketing efforts. 97.
In its 2005 Form 1.0-K, NetBank reported that "[n]on-interest expense
also increased due to the implementation of the QuickPost initiative as well as increases in software maintenance expense ." The Company also reported that "improvements in earnings were offset, in part, by increases in operating expenses of some $8.735 million, primarily relating to the growth in our auto lending and leasing
operations, as well as the introduction of our QuickPost initiative." 98.
In its Form 10-Q for the period ending March 31, 2006, NetBank
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reported that "operating expenses increased by $2.594 million primarily due to
increases in expenses related to our QuickPost initiative." 99.
During NetBank's conference call with investors for the period relating
to the forth quarter of 2005, Quick Post was repeatedly touted: A - Steven Herbert And second thing you asked about, quick post, quick post continues to go very well.... A - Steven Herbert So if you remember what our model is, we have the super regional bank model, which is full service financial institution with the exception and our region is the internet, which has to say that we offer the second largest bank, ATM network to our customers, we offer quick post which actually gives them better, convenience for making deposits or payments, and better funds availability, than most of the large banks, so we don't intend to be a product player, we intend to be a distribution can do it player, which says to me that full service financial institution, delivered over the internet to a highly targeted group of customers.
Q - Mark Sproule Got you, and then with the transaction servicing side I mean how do you look at building that out of - is the return on building the kind of ATM network cost effective or is it more beneficial to your branding effort especially given sort of quick post build outs etc?
A - Steven Herbert Well its, taste great analyst filling, it is absolutely a cornerstone ofour ubiquitous convenience value proposition to our bank customers and -58-
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secondarily the way we run the ATM business to remind you we own less than 5% of the ATMs so its not capital dependent on us to be able to do this. So it's a situation where at large mega bank as it cost down so much per year to provide ATM access to the customers, in my case T make so much year by providing ATM access to my customers, so when your $5 billion bank you have to be smarter than the average bear and we re-engineered the ATM business value proposition from an outflow to an inflow. We would expect Quick Post to overtime be the same thing, we now have unprecedented convenience to our customers who need a place to make a deposit or make a payment, we granted that quick post so we could sell that to other banks customers like USAA and others who will come into that system we believe overtime and create a proposition again when we provide unprecedented ubiquitous convenience to our customers and make money on that channel at the same time.
100.
During NetBank's conference call with investors for the period relating
to the first quarter of 2006, the Defendants continued to tout the prospects for Quick Post despite their knowledge that the initiative was failing: Our main areas of focus in the coming months will be three fold...and number three, move quick post towards profitability by leveraging current partnerships and pursuing new ones. ^^xx
A - Steven Herbert That's correct, Mike. The Retail Bank did show some loss, while NetBank Business Finance had a better quarter on somewhat higher volumes, really drove that, and somewhat reduced the moderating provision loans for the bank standing alone. Retail Bank standing alone reported a $1.4 million loss. A good bit ofthat or actually the vast majority of that relates to, at least in part, to the investment that we
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continue to make in the QuickPost product. A - Douglas Freeman And the issue in here will be QuickPost and PowerPost, and those arc the strategic initiatives as we move forward managing through that.
101.
During NetBank's conference call with investors for the period relating
to the second quarter of 2006, the Defendants stated: As we explained in the press release, the primary driver to QuickPost expenses is the number of UPS stores sending packages in each day. About two-thirds of the stores are now generating packages on a daily basis. The cost for these packages remains the same, whether there is one deposit in a package or 20. The key is now to increase the number of deposits or payments contained in the packages.
The headline really inside the retail bank is the QuickPost, PowerPost and NetServe expenses which we pulled out to enhance people's ability to sort of see the numbers, or this additional detail, I think, adds some color to what's really going on there. That operation has a heavy initial marginal fixed cost structure, so those marginal fixed costs are frontloaded as volumes come on board. So we've seen a significant uptick in the expense structure, and that's what accounts for the increase that we've seen in the next expense from QuickPost, PowerPost and NetServe as we continue to make an investment in those initiatives.
The retail bank, excluding the Quick-Post, PowerPost and NetServe initiatives posted about a $1.6 mill ion operating profit after taking out the HELOC gain on sale and overall, obviously, we got leverage longtenn and a flat yield curve that's going to probably slowly grind against those numbers or work against improving it, so we're slightly negative -60-
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on the outcome that we would probably see there after adjusting.
QuickPost, PowerPost, NetServe, most of the fixed costs are probably in the numbers that you're looking at in the current quarter. They probably will get a little bit worse before it gets better. We are, I guess, optimistic that it won't get too much worse before wve get to the volume levels that will start to result and it'll move back towards breakeven or profitability for those investments.
Q- Hi, guys. Yes. Daniel Hayes in for Mark Sproule. Is there any way for you to quantify the benefit of the QuickPost contribution - sorry if you've already mentioned this -- to earrings growth, to the earnings asset growth, and maybe quantify more of the expenses surrounding QuickPost?
A - Doug Freeman Yeah, I think - this is Doug, Daniel. We have started to breakout the expense stream so that you all can start getting a handle on the expenses associated with it. Secondarily, a couple of months ago we began to break out QuickPost volume back 12 months historically. So with that being said, at some point in time you all are going to be able to get your hands around the marginal costs, marginal revenue associated with that. But as of today, the only metrics that we give you are the total expenses and then the volume.
M. During NetBank's conference call with investors for the period relating to the third quarter of 2006, Defendants stated: We have made the hard decision that we had to make with respect to QuickPost and FTI and we are in process of exiting that business and expect it to be completed by the end of the year, check it off the list.
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In the second quarter, the retail bank earned $1.8 million, if you exclude the QuickPost expenses and take out the gain on sales of HFLOC. 103.
During NetBank's conference call with investors for the period relating
to the third quarter of 2006, NetBank reported that "we were still in our QuickPost
operation losing S3 million a quarter, trying to prepare for a future far off into the distance." 2.
Failed ATM network and Check Clearin g Business
104. According to a confidential witness, who was a senior executive officer of NetBank during most of the Class Period, and who had direct daily contact with the top executive officers, the Company's network of ATMs was an integral part of NetBank's Internet banking model, but never gained acceptance with customers.
Despite Defendants ' knowledge that NetBank 's ATM network and related Check Clearing business were failing, the Company continued to allocate capital to them because in the face of mounting subprime losses NetBank could ill afford to risk eroding its depositor base if it abandoned its ATM network. 105.
According to a confidential witness, who was a senior corporate officer
of NetBank during most of the Class Period, and who provided input directly to defendants Freeman, Herbert, and Gross, the ATM business purchased by NetBank -62-
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was the 2" largest network in the U.S. However, the Defendants knew that the network of ATMs was located in non-strategic locations that made it ineffective for the purpose of generating sufficient acceptance and use by NetBank's depositor customers.
106. According to a confidential witness, who was a senior executive of NetBank during the entire Class Period, and who had regular daily interaction with defendants Freeman, Herbert and Gross, the Defendants knew that Quick Post and NetBank's ATMs were flawed initiatives.
3.
Warehouse Line of Credit
107. NetBank and Meritage maintained a warehouse line of credit which was essential to the continued operation of the Company' s mortgage business . Meritage
used and relied upon that line of credit to make subprime loans and could not have generated the level of subprime mortgage loans that it did during the Class Period had
it not been for Meritage's reliance upon the line of credit. 108. A warehouse line of credit ("WH") is a revolving debt facility or line of credit in which a mortgage banker, such as Meritage, arranges for a loan from a warehouse lender. The original note from the loan is then kept by the warehouse
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lender while the remainder of the documents go to the mortgage banker, who then offers it for sale. When an investor purchases the loan, the warehouse lender gives the original note to the investor. The purchase price is given to the warehouse lender to pay for the advances and fees. The mortgage banker then keeps the remainder of the proceeds from the sale. This cycle starts over on the next loan. 109.
WHLs are typically used by mortgage bankers, such as Meritage, for a
variety of reasons including: (1) the control of funds by the mortgage banker, since it has more control over the process of drawing loan documents; (2) permanent funding, since typically unless the loans fail to comply with agreed upon criteria, the lender is not obligated to buy back loans-the line of credit provides permanent funding for the life of all loans in this program; (3) reduced risk, since once the asset
is funded, there is no additional mark-to-market and. posting of collateral and no margin calls ; (4) unlimited loan volume, whether on or offbalance sheet , since WHL programs can potentially fund an unlimited loan volume which enables specialty lenders to enlarge their portfolios for maximum interest income and eliminate the need to manage multiple sources of capital. 110.
According to a confidential witness, who was a senior executive of
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defendants Freeman, Herbert and Gross, E&Y's continued refusal certify NetBank's prior financials after E&Y resigned led to NetBank's loss of its WHL, which was a contributing factor to the demise of NetBank. As the Defendants were aware, if E&Y
refused to certify NetBank's financials, making it impossible for NetBank to file financial statements with the SEC, the Company's stock would be delisted which, in turn, would cause the Company to lose its WHL. As alleged, the maintenance of its WHL was essential to the continuation of operations at Meritage. 4. 111.
Mortgage Underwriting by Meritage
Underwriting . Meritage was comprised oftwo separate regional centers.
The Jacksonville, Florida center's function was to bring in new subprime mortgages;
the center in Oregon. was to package the mortgages into portfolios and then sell those portfolios of loans to investors. 112.
Meritage relied upon independent mortgage brokers to generate the sub-
prime mortgages that it packaged into portfolios for sale. According to a confidential witness, who was senior managerial executive of Meritage during most of the Class
Period, as a result of the manner in which Meritage generated its subprime loans, the Company had little control over the quality of the loans available to it for purchase.
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As a result, in order to reduce the risk of purchasing low quality loans that carried a high risk of early default, it was necessary for Meritage to adopt stringent standards
of review and to develop strong long-term relationships with reliable brokers. However, according to that confidential witness, in most instances, the brokers bringing loans to Meritagc were "one-time broker[s]" for Meritage while others might
bring Meritage only a few loans and none of the brokers were "regulars" that had an ongoing relationship with Meritage. 113.
The types of subprime mortgages that Meritage sought were largely
dictated by the criteria that investors, the ultimate purchasers, wished to purchase. In the Oregon segment of Meritage, Rick Baldwin was the individual in charge of the secondary marketing for Meritage. As such, Baldwin worked with the investors who ultimately purchased the portfolios of Meritage subprirne loans. According to a confidential witness, who was senior managerial executive of Meritage during most of the Class Period, the underwriting guidelines used by Baldwin and Meritage were not uniform. Rather, Baldwin and Meritage utilized unique underwriting guidelines
for each investor. Individual agreements were then reached with each investor which contained the responsibilities of the investor and Meritage including the terms under which loans could be "put back" to Meritage. To address the attendant complexity, -66-
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all of the various underwriting guidelines were combined into a single homogeneous set of underwriting guidelines to be used by the Jacksonville branch when they brought in the loans from mortgage brokers. According to this confidential witness, the true purpose of the homogenous underwriting guidelines was to answer the question "at the end of the day, wi 11 the investor buy the portfolio?" In sum, according the confidential witness, if the answer to that question was "yes," then the loan would
be funded, if the answer was "no" the loan would not be funded. 114. As alleged, even where a loan meets the investor's underwriting guidelines, such loans can nevertheless be "put back." Put backs were also referred to as "buy backs" and "kickouts." During 2004 and 2005, loans from the portfolios that Meritage had sold to investors began to be "put back" in ever increasing
numbers. Typically, a loan that met the investor's underwriting guidelines could be put back if it fell into one of two categories: Early Payment Defaults (EPD) or First Payment Defaults (FPD). EPD meant that the borrower defaulted or was delinquent in the first 90-180 days of the loan. FPD meant that the borrower defaulted or was delinquent on the loan's first payment. 115.
According to a confidential witness who was a high-level manager in
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defendant Herbert and, later defendant Gross, among others, by as early as May 2006, Herbert embarked on a plan to reduce the numbers of subprime loans on NetBank's books by selling them to other financial institutions. Although defendant Herbert continued to reassure the investing public on this point, his goal was to get NetBank
entirely out of the subprime lending market. When NetBank sold these loans, they contained a provision of the sale that enabled the purchaser to put these loans back to NetBank in the event of Early Payment Default (EPD) or because the loans were
defective for any reason. 116. By 2006, NetBank and its senior officers learned that the investors who purchased its Meritage subprime loan portfolios had hired due diligence companies
to look for reasons to put back loans to Meritage even where they met the investors guidelines. 117.
In mid-2006, senior managers of Meritage and the Office of Thrift
Supervision, over a three weekperiod, examined Meritage's internal controls. Among
the findings was that Meritage had no process for revealing when the terms o f a loan were changed in the middle of the teen of the loan which could lead to significant losses to the company.
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118. Volume. By March 2005, during a monthly, internal .M. eri.tage conference call, one item of discussion was the fact that certain market conditions, such as the so-called two-year swap, was working against Meritage, thereby reducing its already thin profits. According to a confidential witness who, during most of the
Class Period, was a senior managerial executive of Meritage, Russell Burdsall, who was the NetBank Head of Mortgage Operations, acknowledged that NetBank's
mortgage profits were "razor-thin"; nevertheless, Burdsall directed Meritage executives to "push the volume" of the subprime loans. According to that confidential witness, Rick Baldwin, the then-Director of Capital Markets at Meritage Mortgage, stated on a May 2005 conference call that although. investors were still buying the Meritage portfolios, the profits had been reduced. For example, originally, Meri.tage
had received 106 basis points per loan, which dropped to 101 basis points per loan at that time. As a result, by early 2005, although Meritage continued to produce loans, it either lost money doing so or generated only minimal profit.
119. Rather than reveal the nature of the problems at Meritage, Defendants embarked upon a strategy that de-emphasized risk controls and emphasized volume. This strategy, while a potentially short term fix - aimed at increasing Meritage's
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Meritage and NetBank. 120.
A former high-level manager in NetBank's finance department during
the entire Class Period who reported to Herbert and, later Gross, among others, was
astonished at how low Meritage had allowed the quality of loans and underwriting to become, even providing subprime home loans to people who had gone bankrupt. 121. In addition to NetBank's increasingly lax underwriting standards, the Company's increasing reliance on volume led it to accept and, ultimately, conceal.
losses on put backs that it was not required to accept. For example, in one incident, Charles Mapson, NetBank's Chief Legal Officer, reviewed certain loans that an investors wished to put back to the Company. Although Mapson is understood to have determined that the loans actually met the guidelines and were put back long
after the 30 day guideline limit, he approved NetBank's repurchase of the loans to ensure a continuing relationship with the investor which was essential to the generation of an ever increasing volume of loans to support NetBank's razor thin margins.
122. As set forth in the above section and as alleged elsewhere herein, Defendants' made material misrepresentations and omissions regarding NetBank's
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transition as a subprime lender. As such, Defendants failed to properly disclose that the nature of NetBank's core banking business was deficient, and that the focus of NetBank's mortgage lending business had shifted from conservative, conforming mortgages to making a late entry into subprime lending and other risky lending practices. 123.
OTG Audit Report. The above omissions have now been confirmed in
an Audit Report by the Office of Inspector General, Department of the Treasury,
dated April 23, 2008, titled "SAFETY AND SOUNDNESS: Material Loss Review of NetBank, FSB" (the OIG Audit Report"). That Report presents, among other things, the results of the OIG's review of the failure of NetBank, FSB -- a failure that the FDIC estimates will cost the Deposit Insurance Fund some $108 million. Specifically, the OIG Audit Report found that large losses related to NetBank's mortgage banking operations and commercial lease portfolio were among the
significant causes of NetBank's failure. The OIG Audit Report cited that not only did NetBank's mortgage lending practices contribute to its demise but also the fact that the Company did not have a viable core banking business as it constantly touted: While its mortgage banking operations did contribute substantially to NetBank's earnings, by mid 2005 these earnings began to contract. At
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the same time, the secondary mortgage market was experiencing a dramatic downturn. Rather than curtail its mortgage banking operations when faced with this deteriorating earnings scenario, NetBank instead attempted to increase loan production by lowering its underwriting and documentation standards. Not surprisingly, this led to poor loan quality. NetBank sold these loans on the secondary mortgage market with recourse provisions to investors. Recourse provisions out] me the terms when the investor can request the thrift to buy back the loans. Ultimately, in 2006, NetBank had to make good on many of those provisions and repurchase $182 million in loans. Ultimately, when NetBank's mortgage operations became unprofitable, it did not have a profitable core business to fall back on.
124.
The OIG Audit Report provides a chronology of NetBank ' s entry into
the subprime lending market and the Company's subsequent collapse, which appears to confirm Plaintiffs historical recitation set forth above, reporting in pertinent part: NetBank responded to declining gains on the sale of loans by attempting to maintain high loan volumes at the expense of the quality of loan originations. This resulted in an increase in repurchase requests from the buyers of the sold loans. The thrift repurchased $1S2 million of mortgage loans in 2006 and recorded related loss provisions totaling $78.1 million.
Beginning with the first quarter of 2006, NetBank began reporting increasing levels of quarterly losses. 'The thrift reported a pre-tax net loss of $203.6 million in 2006, with $80 million of that loss incurred in the fourth quarter. NetBank's other business lines were not sufficiently profitable to offset the mortgage banking losses and, in some cases, contributed to the reported loss. In October 2006, NetBank's chairman of the board/CEO resigned.
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In the latter half of 2006, NetBank management pursued several strategies to counter its losses, including selling several business lines and some loan portfolios and terminating the subprime mortgage banking operation. These strategies were not successful, as evidenced by the losses in 2006 which continued in 2007. An agreement to sell almost the entire thrift was entered into with EverBank. Financial Corporation in May 2007. As NetBank sold off or exited business lines in preparation for the sale, its losses continued, totaling $120.2 million for the second quarter of 2007. The sale to EverBank Financial Corporation was not consummated because NetBank did not have sufficient cash and saleable assets to close the transaction under the terms of the agreement. With no viable plan for the thrift to restore capital and achieve profitability, OTS exercised its authority to close the institution and appointed FDIC as receiver on September 28, 2007.
125.
Moreover, the O1G Audit Report confirmed that NetBank not only
surreptiously shifted its mortgage lending into the risky subprime market, but that
NetBank's claims of diversification were bogus, as the Company did not even have a viable core banking segment: Lack of Consistent Core Earnings NetBank never established a consistent profitable core business .... NetBank offered relatively high interest rates on deposit accounts and covered these deposit costs by investing in a mix of loan portfolios with higher yields and credit risk. Rather than incurring loan origination costs, NetBank paid premiums to acquire loan portfolios necessary to achieve the asset mix it desired. The savings from not maintaining an in-house loan origination function did not prove adequate to compensate for the premiums paid for loans that the thrift purchased.
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The net yield on the thrift's loan portfolios did not cover deposit costs and G&A. expenses to the extent necessary to produce core earnings performance at the peer group median level. As a result, as discussed above, NetBank. acquired Market Street and RBMG and became entirely dependent on mortgage operation income for profitability. The initial profitability of this segment masked underlying weaknesses, including unusually high operating expenses, ineffective controls of its various subsidiaries and insufficient core earnings.
B.
Defendants' Sham Restructuringof NetBank
126.
On March 16, 200 5 , Defendants filed the NetBank's Form i 0-K for the
fiscal year ended December 31, 2004. That filing reported the Company's financial condition as of December 31, 2004 and financial results for fiscal year 2004, including that net income for 2004 was some $4.22 million or $0.09 per share, compared to net income of some $50.514 million or $1.04 per share, for 2003. That
Filing also described NetBank's operations and its supposed restructuring efforts, including for example that: During 2002 and 2003, the retail banking segment implemented a number of strategies to improve earnings. It restructured its portfolio of assets away from higher to lower risk loans.
NetBank believes that its deposit base will continue to grow as Internet usage and Internet-based commerce grow. NetBank believes that it can continue to invest those deposits profitably in mortgage loans held temporarily for sale and loans held for investment. NetBank also
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believes that its non-interest earnings in the form of fees and gain on sale resulting from its financial intermediary and transaction processing activities will provide a better diversity of earnings than the traditional banking model. 127. During a May 4, 2005, conference call with investors, Defendant Freeman assured investors that not only was the restructuring plan effective , but that the banking segment was can ying a significant portion of earnings: We continue to make measurable progress in diversifying your Company's revenue across its three primary operating segments. You take a peek for a minute at the long-term view, you see a company with a strong business plan, a rapidly improving bank that has begun to carry a significant portion of the Company's earning obligation, and I can't stress again how much we have improved bank performance over the past 24 months.
We're now two years into our evolutionary strategic plan. Since the beginning of the process, we've always felt the Company was a good investment on the strength of our business plan, capital position, and management team. This belief is even stronger today given the measurable progress we've had against many of the critical objectives we detailed for you. Our top priority has always been to generate significant rewards for our investors and we think we can do that for shareholders who share this long-term view.
128. On the strength of defendant Freeman's assurances, NetBank's stock price rose from $8.38 on May 3, 2005, to $8.53 on May 4, 2005. 129. For a time, the new NetBank's attempt to shift away from its core retail -75-
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banking model under Freeman and Herbert appeared to be working. On August 3, 2005 , defendant Freeman reassured the investing public, stating: At the bottom line, what investors are getting with Net Bank is as follows -- a company with an increasingly balanced, stable earnings profile, an undervalued lending franchise with tremendous earning power over the full economic cycle, an attractive base of multi-product, high-value retail bank customers.
130. However, by 2006, due to the combination of the bursting of the U.S. housing bubble and the mounting exposure from subprime and other risky mortgage practices, NetBank's operations and finances faced increasing pressure. Demands for repurchases of loans and defaults increased significantly and investors began to limit their purchases of mortgage portfolios. As a result, the cash available to NetBank to
lend to borrowers was constrained. This liquidity crisis led NetBank to restructure the Company to conserve capital and preserve tangible book value. NetBank's purported "restructuring" had four major components: (1) the sale of its mortgage servicing
platform; (2) the sale or exit of the Company's non-conforming mortgage business; (3) the sale of other non-core operations; and (4) the raising of capital through a private placement of NetBank common stock. 131. In February of each year, the NetBank Board of Directors met and
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received a presentation from NetBank's top management regarding the Company's long-term strategic plan. According to a confidential witness who was a senior
corporate officer ofNetBank during most of the Class Period and who provided input directly to Freeman, Herbert, and Gross, in February 2006, the NetBank Board of Directors were aware of the Company 's perilous situation and demanded that the
Company be restructured. 132.
On March 15, 2006, NetBank Filed its Form 1.0-K for the fiscal year
ended December 31, 2005, which was signed by defendants Freeman, Herbert, Muller, Adams, and. Johnson. That filing reported the Company's financial condition
as of December 31, 2005 and financial results for fiscal year 2005, including that the Company suffered a net loss for 2005 of some $180, 000 or $0.00 per share,
compared to net income of some $4.22 million or $.09 per share, for 2004. The 2005, Form 10-K also described NetBank's operations and. its supposed restructuring efforts, including for example that: In 2003, we announced a strategy to diversify our earnings so that one third is provided by each of our principal operating segments: retail banking, financial intermediary and transaction processing. Over the long-term, our goal is to achieve a better, more stable, balance across our different segments.
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On May 1, 2006, after repeatedly assuring investors about the success
of its restructuring plan, NctBank began to implement the Board 's February 2006 directive and announced a plan to sell its mortgage servicing platform along with
most of its mortgage servicing rights portfolio. The Company represented that "[m]anagement estimates such a sale would likely free up between $20 and S35
million in risk-based capital that the company currently has allocated to its servicing asset . Management would then have the opportunity to redeploy this capital in other business initiatives that it believes can generate higher returns or better serve shareholder interest." NetBank also represented that the proposed sale was part of "management ' s continuous, proactive capital management program ." After years of purporting to expand its sound core banking strategy to grow and deliver shareholder
value by leveraging those assets, NetBank acknowledged that: "The economic and market environments have changed dramatically since we initiated our plan, and we have not been able to achieve the level of growth in the servicing asset we had anticipated," Freeman added. "Given prevailing business conditions, we have determined the mortgage servicing business no longer represents the best use of our capital."
"Our obligation first and foremost is to create value for our shareholders," Freeman concluded. "Although we will continue to plan for the long-term and persist in the face of short-term operational -78-
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pressures when it is right to do so, we will also remain flexible and have the conviction to revise our business strategy when it clearly furthers the interest of our shareholders."
Other details or likely results of the proposed sale include:
-The sale would entail a significant one-time restructuring charge. However, management would seek to moderate the impact of the charge on the company's tangible book value. The effect on tangible book value would be part of management's criteria in approving any transaction.
As of March 31, the company's core servicing asset was comprised of $ 13.0 billion in loans. Management believes the underlying mortgage servicing platform could be scaled up to the $35.0 billion mark almost immediately using the operation's existing facility and infrastructure. 134.
On this news, NetBank's stock price rose from $6.84 per share on May
1, 2006 to $6.94 per share on May 2, 2006. 135. On May 2, 2006, a media report in American Banker discussed NetBank's plan to sell off its mortgage servicing platform and operation. In the
article, Defendant Freeman was quoted portraying the sale as a benefit to the Company's strong banking segment: Such a sale would free up to $35 million in risk-based capital -- "a pretty big number for us," said Douglas K. Freeman, NetBank's chairman and chief executive. The capital could be redeployed "back into our Internet
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bank or other more profitable activities," he said in an interview. He would not say what those other activities were, and he made it clear that he has no interest in getting into brick-and-mortar retail banking, despite one analyst's advice that he should. But he reiterated that NctBank is reexamining its game plan. When the capital is freed up, the .$4.8-billion asset company will be able to gather more deposits and increase assets, Mr. Freeman said. "We continue to find great growth on the deposit side ofthe business. ... Your balance sheet has to balance, last time I looked." 1 36. The statements set forth. in the above subsection were materially false and misleading because they failed to disclose that the Company's financial distress was due to the failure of its core operations, that selling off parts of its mortgage business or other non-core operations would not be enough to resuscitate the Company and that the Company's accounting for its mortgage business was improper.
137.
Without disclosing its mounting troubles with the SEC, its auditor E&Y
and its core retail business, on October 5, 2006, NetBank announced that defendant Herbert would assume the position of CEO, replacing defendant Freeman. In a Form 8.K filed with the SEC on October 5, 2006, defendant Muller confirmed that NetBank's value was in its core banking business and conforming mortgages, but omitted discussion of the fact that the Company's non-conforming business was at that time highly troubled and threatened the viability of the Company itself: The board believes the company's core strengths reside in its banking
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and conforming mortgage activily..Relentless focus on these operations is the surest path to increasing shareholder value. We think [Herbert] is the right person to guide the company through the changes we will make to pare down costs and leverage these businesses more effectively.
"We believe our bank and conforming mortgage businesses have upside potential, and I am excited about the prospect of leading the company in its next stage of development," says Herbert. "Our main objective over the next three to six months will be to stabilize the company's operating profile and return to profitability as quickly as possible. As we mentioned recently, we anticipate announcing a deal to sell the majority ofourmortgage servicingportfolio soon. We are also actively exploring alternatives for our non-conforming mortgage business. You will now see us move quickly to execute on needed changes in other lines of business outside ofthe core banking and mortgage operations. We have a talented base ofassociates that I believe will support andfully engage in this sapid refocus.
138. On this news , NetBank's stock. price rose from $6.30 per share on October 5, 2006 to $6.33 per share on October 6, 2006. 139.
On October 13, 2006, NetBank issued a press release, which was then
filed in a Form 8-K on October 16, 2006 that signed by defendant Gross. That press
release reported that NetBank had sold the servicing rights on $8.5 billion of mortgages, which represented 70% of its mortgage servicing portfolio, to two buyers,
but took a higher-than-expected $19.3 million loss. NetBank continued to conceal its difficulties with the SEC by omission. Rather than disclosing the truth, NetBank
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reassured investors by emphasizing that it would no longer have the same level of exposure to impairment and hedge-related losses. In part, the press release stated: the company has sold most of its mortgage servicing rights ("MSRs") associated with conventional, agency-eligible loans. These MSRs accounted for approximately 70% of NetBank's portfolio, and the unpaid principal balance ("UP.B") on the underlying mortgages totaled $8.5 billion. The MSRs were sold in two separate transactions. The larger, more significant deal involved MSR.s for Fannie Mae and Freddie Mac loans. These MSRs had a related UPB of approximately $8.2 billion, and they were acquired by IXIS Real Estate Capital Inc. ("IXIS"). A different buyer purchased a pool of Ginnie Mae MSRs with UPI3 of approximately $230 million. Both transactions closed on September 29 and were recognized as third quarter events.
Financial and other details of the sale include: One-time expenses of approximately $0.61 per share. The combined sales price for the MSRs was $119 million, which fell below the carrying value that the company had recognized on these particular MSRs. As a result of this difference, the company recorded an after-tax loss of $19.3 million on the sale. The company also elected to liquidate the Ginnie Mae mortgage-backed securities that it held as an on-balance sheet hedge. The company recorded an after-tax loss of S8.7 million on the sale of those securities. These charges along with other transactionrelated costs equate to after-tax expenses of $28.1 million or S0.61 per share.
Limited impact on tangible book value. The sale of the company's onbalance sheet hedges improved the company's equity position on an after-tax basis by $1.3.8 million or $.30 per share and partially offsets the one-time expenses outlined above at the equity or tangible book level. -82-
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As hedges, the Ginnie Mae securities were valued on a mark-to-market basis. The value of these hedges improved throughout the third quarter. The company ultimately realized a smaller loss on these hedges than the
unrealized loss it recognized in its equity calculation on June 30, 2006. x* ::x
"The cost of selling these MSR.s exceeded our initial expectations, but we believe the entire transaction and the timing of it serve the long-term interest of our company and shareholders," said Steven F. Herbert, chief executive officer. "The transaction immediately improves the operating profile of'the company as well as our bottom line. By reducing the size of our MSR portfolio, we eliminate significant earnings volatility. We will no longer have the same level ofexposure to impairment and hedgerelated losses. The bank's net interest margin should see incremental lift following the liquidation ofthe on-balance sheet hedges. We also felt the intrinsic value ofthe sub-servicing contract provided a ineaningfid offset to the lower price."
140.
On this news, NetBank's stock price rose from $6.11 per share on
October 13, 2006 to $6.17 per share on October 16, 2006, the next trading day. 141.
The statements set forth in the above subsection. were materially false
and misleading because they failed to disclose that the Company' s financial distress was due to the failure of its core operations , that selling off parts of its mortgage business or other non-core operations would not be enough to resuscitate the Company, that the Company' s accounting for its mortgage business was improper and omitted that the SEC had challenged the Company's improper accounting treatment.
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NetBazik's purported "strategic restructuring" continued when, on
November 6, 2006, the Company issued a press release in which it announced that it had exited its various non-conforming loan financing businesses by selling Meritage and Beacon. The Company's non-conforming financing operations were so deficient
as to be worthless. In the press release NetBank explained: The company did not receive any material financial or other considerations under the agreements, but management viewed them as a positive since they allowed the company to mitigate substantial severance and shutdown costs that the company would likely have incurred otherwise. Since the agreements did not cover the full scope of the operations, the company still has personnel and other commitments to address to fully exit both lines of business. Management currently expects to record pre-tax expense of $6.0 million to S7.5 million in the fourth quarter to cover those remaining obligations. The company had already written off the goodwill related to both businesses.
"Since the beginning ofOctober, we have been working aggressively to refocus the company on its core banking and confor°mning mortgage competencies ," said Steven F. Herbert , chief executive officer.
"We said then that our priorities were to exit or spin off any underper_forming or non - core businesses so we cou ld restore the company to profitability as quickly as possible and to improve the company 's overall operating profile. Our decision to exit the nonconforming mortgage and RV , boat and aircraft lending businesses contribute to those goals in a meaningful way, especially when you consider the steepness of the quarterly losses we have been incurring in the non-conforming channel."
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"We also committed to protecting capital as much as possible during this process," Herbert continued. "We were happy to execute the transactions that we did since they saved us real dollars in severance and shutdown costs. But, regardless of the deals, it was critical for us to move quickly on these businesses. The cost of carrying them for another quarter or two would have destroyed more value than we probably could have derived under the best possible transaction circumstances."
The company announced its plan to refocus on its banking and conforming mortgage operations along with a change in executive leadership on October 3, 2006. Ivlanagelment has indicated that it intends to exit the lines of business it considers non-core and to make any other related business adjustments by the end ofthefirst quarter of 2007, although it hopes to complete the bulk of the effort by the end of 2006. 143.
The statements in the above subsection were materially false and
misleading because they failed to disclose that the Company' s financial distress was due to the failure of its core operations, that selling off parts of its mortgage business or other non-core operations would. not be enough to resuscitate the Company and that the Company's accounting for its mortgage business was improper. In addition,
it failed to disclose that the Company' s tangible book value was declining rapidly, even with the restructuring , due to the failure of the Company' s core businesses.
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C.
Defendants Falsely Assure Investors That They Can Rev on NetBank's Book Value
144.
On May 4, 2005, NetBank held a conference call with analysts and
others to discuss the Company's financial results for the first quarter of 2005. During that call, Defendant Freeman stated: Book values slipped by $0.20 to $8.70 during the quarter. The decline in interest rates environment experienced during the quarter affected the value of securities and the banks investment portfolio, most of the decrease in book values attributable to an unrealized loss of net portfolio. I point out that this is simply a one-dimensional view. Over time we fully expect book value to trend upward.
1.45.
In an effort to mislead investors into believing that the NetBank's book
value was an accurate measure of their investment, NetBank continued to repurchase shares of its common stock and continued to reassure investors about the value of those shares. For example, during NetBank's May 4, 2005, conference call with analysts, Defendant Freeman reported: The Board of Directors approved a dividend of $0.02 per share and authorized an additional 1 million shares for our stock repurchase program. As we reported in the press release, we repurchased approximately 424,000 shares at an average price of $9.29 per share during the quarter. As current trading price, we continue to believe that our stock represents the best investment of available capital.
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Less than one year later, on May 1, 2006, NetBank announced a plan to
sell its mortgage servicing platform along with most of its portfolio of mortgage
servicing rights. However, recognizing the importance investors placed on NetBank's book value as a measure of their investment, NetBank assured investors that it would undertake to moderate the impact from the sale on the Company's tangible book value as follows:
Other details or likely results of the proposed sale include: • The sale would entail a significant one-time restructuring charge. However, management would seek to moderate the impact ofthe charge on. the company's tangible book value. The effect on tangible book value would be part of management's criteria in approving any transaction.
147. fn a November 8, 2006 press release NetBank explained: Tangible book value is defined as total shareholders' equity reduced by recorded goodwill and other intangible assets. Tangible book value per share is defined tangible book value divided by total common shares outstanding. These non-GAAP financial measures exclude from total shareholders' equity our recorded goodwill and other intangible assets. Management believes that these non-GAAP financial measures, when considered together with the GAAP financial measures, provide information may be helpful for those investors who seek to evaluate our total stockholders' equity without giving effect to goodwill and other intangible assets. Management also believes that these non-GAAP financial measures enhance the ability of investors to analyze the company's business trends and to better understand the company's -87-
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financial condition . In addition , the company may utilize non-GAAP financial measures as a guide in its forecasting, budgeting, and long-term planning process and to measure operating performance for some management compensation purposes . Any analysis of non-GAAP financial measures should be used only in conjunction with amounts presented in accordance with GAAP, including total shareholders' equity and goodwill and other intangible assets. 148.
According to BuusinessWeek.coyrn:
Tangible book value indicates the theoretical dollar amount per common share one might expect to receive from a company's tangible "book" assets should liquidation take place.
Generally, book value is determined by adding the stated value of the common stock, paid-in capital and retained earnings, and then subtracting intangible assets (excess cost over equity of acquired companies, goodwill and patents), preferred stock at liquidating value and unamortized debt discount. Then divide that amount by the outstanding shares to get book value per common share.
149. On May 10, 2006, NetBank held an conference call with analysts and others to discuss the Company's financial results for the first quarter of 2006. Significantly, NetBank knew and understood that investors were valuing the Company based on its book value, and understood the need to avoid negatively impacting that calculation, notwithstanding other financial realities. For example, the same May 2, 2006, American Banker article quoted above noted that investors priced
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NetBank's shares on the basis of book value, and not on the basis of earnings, and as a result, a larger than expected restructuring charge for the sale of its mortgage
servicing rights would hurt bookvalue and, in turn, the Company's stock price. Thus, the Defendants knew that it was imperative that they continue to reassure investors about the Company's book value and to ignore certain financial realities in favor of minimizing any negative impact on the Company's book value.
1.50. On November 8, 2006, NetBank announced its operating results for its third quarter ended September 31, 2006. NetBank reported dramatic losses of $73.3 million or $1.58 per share for the quarter, compared with an after-tax loss of S 1.4 million or $0.03 per share during the sane quarter in the prior year. In part, the press
release stated that NetBank: a leading mortgage lender, today reported financial results for the quarter ended September 30, 2006. The company recorded an after-tax loss of $73.3 million or $1.58 per share for the period, compared with an after-tax loss of $1.4 million or $.03 per share during the same quarter a year ago. On a year-to-date basis, the company recorded an after-tax loss of $116 million or $2.50 per share, versus a net loss of $1.1 million or $.02 per share during the first nine months of 2005.
Book value declined by $1.22 per share from $7.48 on. June 30, 2006 to $6.26 on September 30, 2006. However, the impact on the company's tangible book value was substantially less. Tangible book value declined $.70 per share from $5.80 on June 30, 2006 to 55.10 on September 30, -89-
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2006. On an after-tax basis, the reported loss included a $19.5 million expense of non-deductible goodwill and a $2.4 million expense of deductible goodwill, both of which did not negatively impact tangible book value. In addition, the company sold certain on-balance sheet investments allocated as economic hedges of its mortgage servicing rights ("MSRs") during the quarter. The Unrealized loss on these securities was already deducted from tangible book value on June 30 through other comprehensive loss included in the equity section of the balance sheet. Thus, the realized loss on those securities did not impact tangible book value. (Details related to amounts excluded from tangible book value are provided in the attached Reconciliation of Non-G.AAP Financial Measures.)
1 51 . The statements set forth in the above subsection were materially false and misleading because they failed to disclose that the Company's financial distress was due to the failure of its core operations, that selling off parts of its mortgage business or other non-core operations would not be enough to resuscitate the Company and that the Company's accounting for its mortgage business was
improper. In addition, it failed to disclose that the Company's tangible book value was declining rapidly even with the restructuring due to the failure of the Company's core businesses. D.
Defendants Make Additional False Assurances to Investors After E&Y Resigns
152.
On November 9, 2006, Defendant Gross signed a Form S-K filed by
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NetBank with the SEC. In the Forin 8-K, the Company revealed that on October 10, 2006, E&Y had resigned as NetBank's independent auditor. E&Y's resignation as the Company's independent accountant became effective on November 9, 2006, with the filing of the Company's Quarterly Report on Forln 10-Q for the three-month and nine-month periods ended September 30, 2006. 153.
In NetBank's November 9, 2006, Form 8-K, Defendants discussed
certain material weaknesses in the Company's internal controls, stating:
In the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004, which the Company filed with the SEC on March 16, 2005, Management's Annual Report on Internal Control over Financial Reporting stated, and E&Y's report on internal controls reiterated, that because of the material weakness disclosed in those reports, the Company's internal control over financial reporting was not effective as of December 31, 2004, based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. The material weakness in those reports concerned the Company's controls over the determination and estimation of the change in fair value of the Company's portfolio of mortgage loan funding commitments where the interest rate had been locked and the related financial derivatives ("rate locks"). In 2005, the Company implemented certain changes to its internal controls to address the material weakness over the Company's rate locks and determined that the material weakness existing at December 31, 2004 was corrected.
154. Item 4.01(a) of Form 8-K requires the registrant, here NetBank, to disclose the information required by Regulation S-K Item 304(a)(1) and Item -91-
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304(a)(3) when its auditor resigns. The disclosures required by Regulation S-K Item 304(a)(I) regarding disagreements between a registrant and its auditor include: (iv) state whether during the registrant 's two most recent fiscal years and any subsequent
interim period preceding such resignation, declination or dismissal there were any disagreements with the former accountant on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which disagreement(s), if not resolved to the satisfaction of the former accountant, would have caused it to make reference to the subject matter of the disagreement(s) in connection with its report. Also, (A) describe each such disagreement; (B) state whether any audit or similar committee of the board of directors, or the board of directors , discussed the subject matter of each of such disagreements with the former
accountant; and (C) state whether the registrant has authorized the former accountant to respond fully to the inquiries of the successor accountant concerning the subject
matter of each of such disagreements and, if not, describe the nature of any limitation thereon and the reason therefore. The disagreements required to be reported in response to this Item include both those resolved to the former accountant's
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level, i.e., between personnel of the registrant responsible for presentation of its financial statements and personnel of the accounting firm responsible for rendering its report. 155.
By virtue of filing Netbank's November 9, 2006 Form 8-K, Defendants
violated Item 4.01(a) and the related disclosure requirements by falsely representing
that there were no material disagreements between the Company and E&Y, as follows: During each of the fiscal years ended December 31, 2004 and December 31, 2005 and the subsequent interim period from January 1, 2006 through the effective date of E&Y's resignation on November 9, 2006: (i) there were no disagreements between the Company and E&Y on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of E&Y, would have caused E&Y to make reference to the subject matter of the disagreement in connection with its reports on the consolidated financial statements for such years; and (ii) except as set forth in the next paragraph, there were no "reportable events" (as defined in Item 304(a)(1)(v) of Regulation S-K).
156.
NetBank facilitated the foregoing false and misleading statement in the
Form 8-K by stating, "The Company has provided E&Y with a copy of the above disclosures and has requested that E&Y furnish the Company with a letter addressed to the SEC stating whether it agrees with such statements made by the Company. A
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copy ofthat letter, dated November 9, 2006, is attached hereto as Exhibit 16.1." E&Y had certified to the SEC on November 9, 2006, that "We have read Item 4.01 of Form
8-KJA dated November 9, 2006, of NetBank, Inc. and are in agreement with the statements contained in the first four paragraphs in the section, "Item 4.01 Changes in Registrant's Certifying Accountant." Included among the "first four paragraphs" referenced by E&Y i n its November 9, 2006, certification was NetBank's foregoing certification that were no disagreements between the Company and E&Y. 157.
Despite the representations of NetBank and E&Y, according to a
confidential witness, who was a senior executive of NetBank during the entire Class Period, and who had regular daily interaction with defendants Freeman, Herbert and Gross, E&Y had a significant ongoing disagreement with NetBank regarding the
calculation of the Company's hedge effectiveness under SFAS 133. 158.
NetBank had an inventory of mortgages for which they maintained
servicing rights. Under FAS 133, NetBank was required to show its hedge
effectiveness relating to those rights and perform calculations on a monthly basis. However, according to a confidential witness who was a senior executive ofNetBank during the entire Class Period and who had regular daily interaction with defendants Freeman, Herbert and Gross, E&Y advised NetBank and its senior management that -94-
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the Company's hedge effectiveness testing under FAS 133 was not being conducted frequently enough to be reliable and directed NetBank to perform the hedge-
effectiveness on a daily basis. E&Y also directed NetBank to re-calculate the hedgeeffectiveness for previous years back to 2002.
159. According to a confidential witness, who was a senior executive of NetBank during the entire Class Period, and who had regular daily interaction with defendants Freeman, Herbert and Gross, NetBank was also in negotiations with the SEC regarding the frequency with which it performed its hedge-effectiveness under FAS 133. NetBank ultimately reached an agreement with the SEC in which the SEC would permit NetBank to perform a re-calculation for one month out of each quarter in an attempt to demonstrate that the hedging was effective, However, E&Y refused to accept the proposal claiming that it did not believe that it was adequate solution.
For its part, NetBank and its senior management, upon information and belief, refused to accept the assessment of E&Y. On the basis of that disagreement between NetBank and E&Y, E&Y resigned as Netl ank's auditors. 160. According to a confidential witness who was a NetBank officer employed in the Corporate Finance Department throughout the Class Period and who had direct dealings with top management including defendant CFE Herbert, E&Y -95-
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also told NetBank that E&Y was resigning because it was not comfortable with the Company 's financial statements.
161. According to a confidential witness who was a senior corporate officer of NetBank during most of the Class Period and who provided input directly to
defendants Freeman, Herbert, and Gross, E&Y also claimed that its decision to resigned was motivated , at least in part , by its fear of the "potential liability associated with NetBank."
162. According to a confidential witness who was a high-level manager in NetBank's Finance Department during the entire Class Period and who reported to
Herbert and, later Gross, among others, defendants Herbert and Gross were "furious" with E&Y' s decision to resign as NetBank ' s auditors and claimed to believe that E.&Y did so in an effort to distance itself from NetBank. 163.
Despite the serious disagreements between NetBank and E &Y and their
mutual omission of those disagreements , NetBank attempted to further downplay the reasons for E&Y's resignation, stating that "[t]he audit reports of E&Y on the Company's consolidated financial statements for the fiscal years ended December 31, 2004 and 2005 did not contain an adverse opinion or a disclaimer of opinion and were
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not qualified or modified as to uncertainty, audit scope or accounting principles." 164.
Although it could no longer fail to inform the investing public that E&Y
had resigned as NetBank's auditor, Defendants also continued to omit that months
before NetBank had received a comment letter from the SEC regarding the Company's application of SFAS 133 to the accounting of its mortgage servicing
rights and loans held for sale. 165.
With these reassurances, NetBank's stock price increased from $4.99 per
share on November 9, 2006 to 55. 02 per share on November 10, 2006. 1.66. E&Y also continually refused to re-issue its 2004 and 2005 audit report for inclusion in NetBank's 2006 Fonn 10-K unless and until NetBank resolved the SEC's dispute with respect to the Company's application of FAS 133 to the
accounting of mortgage servicing rights and loans held for sale. By the time of its collapse, NetBank had never resolved. the SEC's issues or filed audited financial
results for 2006. 167. The statements set forth in the above subsection were materially false and misleading because they failed to disclose that the Company's financial distress was due to the failure of its core operations, that selling off parts of its mortgage
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business or other non-core operations would not be enough to resuscitate the Company and that the Company's accounting for its mortgage business was
improper. NetBank also omitted that, in fact, the reason for the failure to timely file was Defendants' failure to comply with GAAP in valuing its core mortgage portfolio
and, as a result, its tangible book value. 168. On January 3, 2007, in the final phase of its purported restructuring, NetBank announced a private placement of 6,500,000 shares of its common stock at
a price of $3.90 per share, with proceeds of approximately $23.7 million. 169. The private placement closed on January 5, 2007. On January 8, 2007, NetBank issued a press release, which was then filed in a Form 8-K on that same day which was signed by defendant Gross. That press release stressed that this was one
of the final steps in its restructuring and was intended to, among other things, "maintain [NetBank's] optimum capitalization". In part, the press release stated: "We are pleased with the transaction and believe it serves the best interest of long-term shareholders," said Steven F. Herbert, chief executive officer. "We are in the final phase of the corporate restructuring plan we started three months ago. The plan centers on returning the company to profitability as quickly as possible by exiting underperforming businesses and refocusing attention on our core retail and small business banking operations as well as our prime mortgage businesses. We believe the additional capital will allow us to maintain
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optimal capitalization within the bank; support new asset and deposit growth; and potentially invest in other key initiatives."
"We were deliberate in balancing the benefit of additional capital with the dilution to existing shareholders that this transaction represents," Herbert continued. "By limiting the issuance to a relatively small number of shares, we were able to keep the dilution to approximately $0.10 per share based on a closing market price of $4.64 the day that we priced the deal."
170. As a result of expected dilution of NetBank shares, NetBank's stock price slipped in a roughly equal amount, from $4.30 per share on January 3, 2007 to
$4.14 per share on January 5, 2007. 171.
The statements set forth in the above subsection were materially false
and misleading because they failed to disclose that the Company's financial distress was due to the failure of its core operations, that selling off parts of its mortgage business or other non-core operations would not be enough to resuscitate the Company and. that the Company's accounting for its mortgage business was improper. 172.
On January 3, 2007, in a Form 8 -K Filed with the SEC in connection with
the private placement discussed above, NetBank informed investors for the first time that as a result of E&Y's resignation on October 10, 2006,and the Company's
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inability to find a replacement auditor, the filing of its 2006 Form 10-K might be delayed. NetBank also revealed that the Company's stock may be delisted by the NASDAQ stock exchange if the 2006 Form 10-K was not filed by March 16, 2007. 17 3.
Despite the potentially dire consequences delisting would have on
NetBank's common stock and its public shareholders, the Company downplayed the problem. Rather, it reassured investors by falsely claiming that the Company simply
had not yet been able to find a replacement despite the efforts of NetBank's Audit Committee and that there had been no disagreements between NetBank and Ernst & Young: On October 10, 2006, Ernst & Young LLP ("E&Y"), the independent registered public accounting firm of the Company for the fiscal year ended December 31, 2005, resigned effective upon the filing with the Commission of the Company's Quarterly Report on Form 10-Q for the three-month and nine-month periods ended September 30, 2006. E&Y's resignation as the Company's independent registered public accounting firm became effective on November 9, 2006, with the filing of the Company's Quarterly Report on Form 10-Q for the three-month and nine-month periods ended September 30, 2006. During each ofthe fiscal years ended December 31, 2004 and December 31, 2005 and the subsequent interim period from January 1, 2006 through the effective date of E&Y's resignation on November 9, 2006 there were no disagreements between the Company and E&Y on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of E&Y, would have caused E&Y to make reference to the subject matter of the disagreement in connection with its reports on the -100-
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consolidated financial statements for such years.
Since prior to the effective date of E&Y's resignation, the Audit Committee of the Board of Directors of the Company has been engaged in the process of selecting an independent registered public accounting firm ("Auditor") for the fiscal year ending December 31, 2006.
174.
As a result of NetBank's reassurances, its stock price remained stable,
closing at $4.30 per share on both January 3 and 4, 2007. 175.
The statements set forth in the above subsection were materially false
and misleading in that they falsely led investors to believe that the delay in filing the
2006 Form 10-K was not due to a. substantive issue, but rather was merely the procedural result of not being able to engage an auditor in time to file. These
statements omitted to state that in fact, the reason. for the failure to timely file was the Defendants ' s failure to comply with GAAP in valuing its core mortgage portfolio
and, through that, its tangible book value. 176. More than three months after E&Y's resignation, in a February 16, 2007 idling with the SEC on Form 8-K, NetBank announced that it had selected Porter
Keadle Moore , LLP ("PKM "), as its new independent auditor and repeated the false and misleading statement that it was the procedural delay in selecting a new auditor
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that might prevent NetBank from timely filing the 2006 Form. 10-K. Further misleading investors, the Company falsely represented to shareholders that it expected to file the 2006 Form. 10-K no later than June 31, 2007: On February 13, 2007, NetBank, Inc. (the "Company") engaged Porter Keadle Moore, ,LP ("PKM") as its new independent registered public accounting firm for the fiscal year ended December 31, 2006.
[DJue to the timing ofthe engagement ofPKk[, the Company does not expect that PKMwill be able to perform and complete the audit ofour 2006 financial statements, and related auditor attestation regarding our internal control over financial reporting, by our compliance deadline of'Mareh 16, 2007, the last date the Company is permitted to timely file its Annual Report on Form 10-K for the year ended December 31, 2006 ("2006 Form 10-K") with the SEC. The Company currently believes that the 2006 audit will be completed in June 2007 and expects to file the 2006 Form 10-K with tie SEC on or before June 30, 2007, although no assurance can be given.
177.
On February 21, 2007, NetBank issued a press release, which was then
filed in a Form S-K on that same day which was signed by defendant Gross. That press release announced the Company's preliminary unaudited results for the year ended December 31, 2006. Attempting to explain why it was still unable to issue final audited results, NetBank again created the impression that the only reason the filing
of its 2006 Form l 0-K may be late was that PKM had only been "recently engaged" and that it expected the 2006 Form 10-K would be filed soon stating: -102-
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The results set forth in this press release are preliminary and unaudited. As previously reported, the company recently engaged Porter Keadle Moore, LLP ('PKM'' ) to replace Ernst & Young LLP as its independent auditor. These preliminary results are subject to potential adjustments, which may be material, arising from subsequent events or the audit of the company's financial statements for the year ended December 31, 2006 by PKM. The company currently believes that the 2006 audit, and related auditor attestation regarding the company's internal control over financial reporting, will be completed in June 2007 and expects to file its Annual Report on Form I 0-K for the 2006 fiscal year with the SEC on or before June 30, 2007, although no assurance can be given.
178.
As a result of defendants' false assurance on February 16 and 21, 2007,
NetBank's stock rose from $3.55 per share on Friday, February 16, 2007 to $3.62 per
share on February 21, 2007. 179. The statements set forth in the above subsection were materially false and misleading in that they falsely led investors to believe that the delay in filing the 2006 Form 10-K was not due to a substantive issue, but rather was merely the
procedural result of not being able to engage an auditor in time to file . These statements omitted to state that in fact, the reason for the failure to timely file was the
failure of Defendants to comply with GAAP in valuing its core mortgage portfolio and, through that, its tangible book value.
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NetBank Continues to Falsely Reassure Investors About
the Comp any's Condition and O p erations 180.
On February 21, 2007, NetBank announced its preliminary unaudited
results for the year ended December 31, 2006. NetBank recorded an after-tax loss of $86.3 million or $1.86 per share during the fourth quarter, compared with net income of $895,000 or $0.02 per share during the same quarter in 2005. NetBank further
recorded a net loss of $202 million or $4.36 per share for the full year, compared with a net loss o f $180,000 or 50.00 per share for 2005. 181. The February 21, 2007 report of NetBank's fourth quarter and year end 2006 financial results also contained a section called "Key items worth noting" in which management represented that the "worst of the non-conforming loan repurchase problem is now behind the company" and that the impact of the
restructuring on the Company's tangible book value was "lessened, being reduced only to $3.50 on December 31, 2006 from $5.10 on September 30, 2006." The press release also stated: Management believes the worst of the non-conforming loan repurchase problem is now behind the company given the accelerated repurchase requests already received relative to the limited non-conforming production over the second half of 2006.
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Impact on Tangible Book Value Lessened. Book value declined by $1.94 per share from $6.26 on September 30, 2006 to $4.32 on December 31, 2006. However, the impact on the company's tangible book value was less. Tangible book value declined by $1.60 per share from $5.10 on September 30, 2006 to $3.50 on December 31, 2006. Oil an after-tax basis, the reported loss included the $9.7 million write down related to the company's ATM and merchant processing business mentioned above that did not negatively impact tangible book value. (Details related to amounts excluded from tangible book value are provided in the attached Reconciliation of Non-GAAP Financial Measures.)
182. The statements set forth in the above subsection were materially :false and misleading because they failed to disclose that the Company's financial distress was due to the failure of its core operations, that selling off parts of its mortgage business or other non-core operations would not be enough to resuscitate the Company and that the Company' s accounting for its mortgage business was improper. In addition, it failed to disclose that the Company's tangible book value
was becoming worthless even with the restructuring due to the failure of the Company's core businesses. 183.
The February 21, 2007 announcement orNetBank's fourth quarter and
year end 2006 financial results also contained a section called "Management Commentary" in which Defendant Herbert told investors that "in the span of 90
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days," NetBank was able to "substantially execute a restructuring plan designed to stabilise the company's operating profile and capital position," and that the Company
had .finally "emerged" from the "tunnel" of the restructuring having moved closer to NetBank's goal ofrestoring profitability and stabilizing book value.The press release stated, in part: "I'm proud of the fact that, in the span of 90 days, we were able to substantially execute a restructuring plan designed to stabilize the company's operating profile and capital position. During the quarter, we sold, exited or shut down our non-conforming mortgage operation; our RV, boat and aircraft financing business; FTI and the QuickPost service; and Netlnsurance. We consolidated two of our indirect conforming mortgage operating centers into our Columbia facility, and during December, we substantially effected a shut down of our auto lending unit.
The final item remaining to be checked off our 'to do' list is the completion of the sale of our ATM and merchant processing business. We have a non-binding letter of intent in place and we are optimistic that a definitive agreement will be reached soon and the deal will close by the end of the first quarter. T am also pleased that we can check off 'engage an audit firm' which wasn't on our original list of things to do.
"When we began this process, T likened it to driving through a tunnel. We had a roadmap, but we went in not knowing exactly what things would look like on the other side. Now that we've emerged, were evaluating our next steps.
"I'd be remiss if I didn't thank our associates for all the hard work they -IO6-
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have done since last October. That work has moved us closer to our goal ofrestoring profitability and stabilizing book value . While we evaluate our next steps , our operating priorities will continue to be moving our indirect conforming mortgage operation back toward breakeven as quickly as possible and generating cost-effective deposit growth at the bank."
184. As a result of this news and NetBank's reassurances, the Company's stock price rose from $3.57 per share on February 20, 2007 to $3.62 per share on
February 21, 2007. 185. The statements set forth in the above subsection were materially false and misleading because far from successfully executing a plan that "stabilize[d] the company's operating profile and capital position" or "emerg[ing]" from the "tunnel"
of the restructuring, Defendants failed to disclose that the Company's financial distress was due to the failure of its core operations, that selling off parts of its mortgage business or other non-core operations would not be enough to resuscitate the Company and that the Company's accounting for its mortgage business was improper. In addition, it failed to disclose that far from "stabilizing book value," the Company's tangible book value was declining rapidly even with the restructuring and
cash infusion due to the failure of the Company' s core businesses. 186. On March 23, 2007, NetBank filed a Form. 8-K with the SEC, which was -107-
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signed by defendant Gross and which attached a press release of the same date. That attached press release announced that on March 20, 2007, the Company had received a letter from the NASDAQ stating that NetBank's inability to file timely the 2006
Form 10-K served as a basis for its stock to be delisted. NetBank thereby further perpetuated the falsehood that the only reason. For its failure to timely file the Company's 2006 Form 10-K was the delay in retaining new independent auditors after the resignation of E&Y. In the press release NetBank: announced that on March 20, 2007, it received a staff determination notice from the Nasdaq Stock Market stating that the company's common stock is subject to delisting.
As previously reported, the company was unable to timely file its 10-K due to the delay in engaging a new independent auditor after its former independent auditor resigned effective 1'ovem.ber 9, 2006. On February 15, 2007, the company reported that it engaged Porter Keadle Woore, LLP ("PKM") to replace Ernst & YoungLLPas its independent auditor. The company currently believes that the 2006 audit, and related auditor attestation regarding the companys internal control over financial reporting, will be completed in June 2007 and expects to file its 10-K with the SEC on or before June 30, 2007, although no assurance can be given.
187. On this news, NetBank's stock price rose slightly from $2.41 per share on March 23, 2007 to $2.42 per share on March 26, 2007, the next trading day.
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On May 14, 2007, NetBank received an additional NASDAQ "Notice
of Non-Compliance" advising the Company of an additional basis for the del i sting of the Company's common stock. 189.
On May 15, 2007, NetBank issued a press release and a Form. 8-K,
signed by defendant Gross, in which it announced that it had received a letter from the NASDAQ stating that while the Company had released preliminary unaudited
results for the December 31, 2006 year, the year-end statements would remain open to "additional evidence with respect to conditions that existed at the date of the balance sheet and affect estimates inherent in the process of preparing the audited
financial statements," and for the first time indicated that this may require NetBank to "push back" and record certain unidentified "subsequent events" in its year-end financial statements . In relevant part, the Netl3ank press release stated: As previously announced, the company received a similar letter on March 20, 2007, when it was unable to timely file its Annual Report on Form 10-K for the fiscal year ended December 31, 2006 (the "10-K"). In response to that letter, the company requested, and was granted, a hearing before a NASDAQ Listing Qualifications Panel. The hearing was held on. May 3, 2007. During the hearing, the company presented its plan for regaining compliance. Since the company is unable to file its I0-Q before its 10-K has been filed, management currently expects to file the 10-K and IO-Q concurrently on or before June 30, 2007, although no assurance can be given.
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The company also announced that it will delay reporting its results for the quarter ended March 31, 2007, until its auditors have completed the audit of the company's financial statements for the year ended December 31, 2006, and the company has filed the 10-K. While the company reported preliminary, unaudited results for its year ended December 31, 2006, the subsequent events period applicable to our financial statements for the year ended December 31, 2006, will remain open until the completion of the audit. Under applicable accounting pronouncements, events that occur or information that becomes available subsequent to the December 3.1, 2006, balance sheet date but before issuance of the year-end audited financial statements that provide additional evidence with respect to conditions that existed at the date ofthe balance sheet and affect the estimates inherent in the process of preparing the audited financial statements would be required to be "pushed back " and recorded in the year-end,financial statements. The company currently expects that it may be required to "push back" and record in its year-end financial statements certain subsequent event items in accordance with these accounting pronouncements. However, until the subsequent events period is closed, the company will not be in a position to review or quantify such charges or their effect o its previously reported preliminary, unaudited results at year-end. Upon reporting final year-end and first quarter results, the company will identify the nature and amount ofcharges, if'any, that were required to be pushed back to 2006.
As previously reported, the company was unable to timely file its 10-K due to the delay in engaging a new independent auditor after its former independent auditor resigned effective November 9, 2006. On February 15, 2007, the company reported that it engaged Porter Keadle Moore, LLP ("PKM") to replace Ernst & Young LLP as its independent auditor.
190. On this news, NetBank's stock price dropped slightly from $1.95 per
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share on May 15, 2007 to $ I.90 per share on May 1. 6, 2007. 191. The statements set forth in the above subsection were materially false and misleading in that they falsely led investors to believe that the delay in filing the 2006 Form 10-K was not due to a substantive issue, but rather was merely the procedural result of not being able to engage an auditor in time to file. These statements omitted to state that in fact, the reason for the failure to timely file was the failure of Defendants to comply with GAAP in valuing its core mortgage portfolio
and, through that, its tangible book value. 192.
According to a confidential witness who was a senior executive of
NetBank during the entire Class Period, and who had regular daily interaction with defendants Freeman, Herbert and Gross, although PKM conducted a 2006 full-year audit, the SEC would not accept the PKM full-year 2006 audit unless E&Y approved
it and reissued its prior certifications, which E&Y continually refused to do. 193. According to another confidential witness who was a senior executive of NetBank during the entire Class Period and who interacted daily with Herbert, Freeman and Gross, E&Y's continued refusal was a contributing factor to the demise of NetBank. The Defendants were aware that if E&Y refused to certify NetBank's
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financials, making it impossible for NetBank to file Financial statements with the SEC, the Company's stock would eventually be delisted. E&Y continued to refuse to certify NetBank's financials. As a result, the Company was assessed penalties by
the FDIC for a lack of timely audit, which ultimately led to the Company's stock being delisted. The Defendants also knew and understood that if the NetBank lost its SEC certification the Company could not maintain its WLC which, as alleged above, was. essential to the continuation of its subprime mortgage operations at Meritage.
194. In the midst of making materially false and misleading statements regarding its failure to timely make required filings with the SEC, NetBank continued to sell off assets in an effort to raise capital, many of which were crucial to its core operations. 195.
On May 1, 2007, NetBank issued a press release in which it announced
that it sold. its ATM and Merchant Servicing Operation for $18 million, which included initial cash proceeds of $16.5 million. Defendant Herbert portrayed this sale as a "win-win" that would increase NetBank's tangible assets and tangible book value
even though he admitted that "NetBank was carrying the assets on its balance sheet at a higher value than the sales price" and, therefore, the Company would "record an additional impairment charge of approximately $2.0 million to bring the book value -112-
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of the assets into line with the sales price." More fully, the press release stated, in part: NetBank Payment Systems sold its principal operating assets and net working capital yesterday to PAT ATM Services, LLC, a subsidiary of Payment Alliance International, Inc. ("PAT"). The assets consisted primarily of servicing contracts on more than 8,500 ATMs nationwide. The sales price for the assets totaled S18.0 million, resulting in initial cash proceeds of $1.6.5 million after adjustment for the estimated book value of the net working capital acquired.
NetBank was carrying the assets on its balance sheet at a higher value than the sales price. The bank will therefore record an additional impairment charge of approximately $2.0 million to bring the book value of the assets into line with the sales price. It is important to note that the ATM servicing contracts were recognized on the bank's balance sheet as intangible assets. Through the sale, the bank monetized them and thus converted them from an intangible into a tangible. This means the bulk. of the cash proceeds represents new tangible capital that management can put to work in additional asset growth at the bank or other cost-saving initiatives. It also directly increases the company's overall tangible book value.
"We mentioned several months ago our intention to sell this operation as part of our larger corporate reorganization ofjbrt," said Steven F. Herbert, Chief Executive Officer ("CEO"), NetBank, Inc. "We said then that the operation was well managed and had real value. But, it simply did not fit in with our core banking and mortgage focus. It required significant capital to operate and therefore represented a strain or distraction on our resources."
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will be able to invest more in the operation and preserve the jobs of the talented team we had in place. In turn, we have generated significant new tangible capital. This money will prove important in our effort to maintain proper regulatory capital ratios and to protect shareholder value as we fight to get the company back on track financially through further restructuring or other alternatives."
196.
On these reassurances to the market that NetBank actually had increased
its tangible book value in this further stage of the restructuring, the Company's stock price rose from $1.96 per share on May 1, 2007, to $2.07 per share on May 2, 2007. 197,
The statements set forth in the above subsection were materially false
and misleading because far from being a "win" for NetBank that generated additional capital for turning around the Company, as Defendants well-knew, no amount of additional funding would save the Company since its financial distress was so deeply
rooted in the failure of its core operations and that its 2004 and 2005 financial statements were false and misleading and could not he relied upon by the investing
public. In addition, it failed to disclose that the Company's tangible book value in fact continued to decline rapidly even with the restructuring and multiple cash infusions due to the failure of the Company's core businesses.
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NetBank Misleads Investors Regarding the Validity of Its FAS 133 Accounting
198. From at least March 16, 2005 through November 9, 2006, NetBank issued financial reports that were materially false and misleading, primarily due to its failure to comply with Statement of Financial Accounting Standard ("SFAS") 133. The misrepresentations had the result of achieving management's desire to mask the fact that its revolutionary business model implemented through, in substantial part, its non-conforming mortgage loan business, was a sham. 199.
In June 1998, the FASB released SFAS 133 which required that, after
January 1, 2001, derivatives be accounted for at fair market value. The standard essentially provides that derivatives must be revalued every reporting period, and changes to value must be reported in the income statement. To achieve hedge accounting in compliance with SFAS 133, a company must associate each derivative
contract with the specific liability, asset or forecasted transaction being hedged. 200.
The Financial Accounting Standards Board issued Statement ofFinancial
Accounting Standards ("SFAS" or "FAS") No. 133 in June of 1998. SFAS 133 governs "Accounting for Derivative Instruments and Hedging Activities." SFAS 133
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certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. SFAS 133 was issued because the effects of the increasing quantity and variety of derivatives used by companies were not transparent in the financial statements. SFAS 133 standardizes the accounting
treatment for derivative instruments by requiring all. entities to report derivatives as assets and liabilities on the balance sheet at their fair value. 201.
Under SFAS 133, if certain conditions are met, a derivative may be
specifically designated as: (a) a hedge of the exposure to changes in the fair value of
a recognized asset or liability or an unrecognized firm commitment; (b) a hedge ofthe exposure to variable cash flows of a forecasted transaction; or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized
firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. 202.
NetBank did not have or maintain the systems or personnel necessary to
perform and generate the foregoing reports to assess the reliability of the Company's
financial derivatives activity . Moreover, had NetBank properly applied GAAP, i.e., correctly applied the traditionally more well recognized. and accepted regression
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conforming mortgage loans to disguise weaknesses in its core banking segment.
203. By failing to comply with the requirements of FAS 133, NetBank failed to qual ify for hedge accounting . This failure resulted in the Company publicly i ssuing materially false and misleading financial statements for the periods covering fiscal years 2004 and 2005. Although E&Y provided unqualified audit opinions for those
years, E&Y later refused to re-issue its 2004 and 2005 audit opinions for inclusion in the 2006 Form 10-K until NetBank resolved the SEC's comments regarding the Company ' s application of FAS 133 in accounting for the Company's mortgage servicing rights and loans held for sale. The vast majority of previously reported net income is a result of NctBank's improper hedge accounting. 204.
In the prospectus, NetBank also claimed that "SFAS 133 is effective for
all fiscal quarters of fiscal years beginning after June 15, 1999." However, NetBank
claimed that "[t]he adoption of SFAS 133 is not expected to have a significant effect on our financial statements."
205. It its 2005 Annual Report issued on or about March 15, 2006, NetBank explained that: NetBank's portfolio of derivatives which are designated and qualify as hedges are accounted for per the guidance set forth in SFAS 133, as -117-
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amended. As such, the Company tests the fair value hedges related to its mortgage loans held for sale and mortgage servicing rights at inception and on an ongoing basis to determine that the derivatives are highly effective in offsetting changes in fair values or cash flows of the respective hedged items. Gains and losses on derivatives hedging servicing assets are included in other income, and gains and losses on derivatives hedging mortgage loans held for sale are included in gains on sales of loans and mortgage servicing rights.
If a derivative fails to meet hedge effectiveness tests, if hedge designation for a derivative is discontinued, or if the asset or liability being hedged is disposed of, the derivative is marked-to-market through the statement of operations and included in other income. The amount ofhedge ineffectiveness was not material ,fc)r the years 2005 and 2004. Derivatives not designated as either fair value or cash flow hedges are marked - to-market through the statement of operations and included in gain (loss) on derivatives with the offsetting entry to other assets or liabilities. 206.
During the relevant period NetBank attempt to conceal its failure to
comply with SFAS 133 by lobbying the SEC to reduce disclosure obligation with respect to its application. For example, NetBank provided comments to the SEC regarding the disclosures required pursuant SFAS 133, which it claimed were "overly
burdensome." Discussing Netbank's arguments against additional disclosures under
SFAS 133, the SEC wrote: Netbank Inc. summed up its arguments against additional disclosures by stating, "If one of the intended benefits of the proposed accounting standard is to provide companies relief from the documentation and -118-
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paperwork requirements of FAS 133, the existence of paragraph (3)(e) may very well put in place a documentation and paperwork requirement that is equally onerous. In drafting the final rule under (3), we ask that the FASB keep the documentation and disclosure requirements as simple as possible."
207. On March 15, 2006, Defendants filed NetBank's Form 10 -K for the fiscal year ended December 31, 2005. That filing discussed NetBank's hedging activities and application of FAS 133 under GAAP accounting, including inter a/ia: The Company utilizes hedge accounting treatment for its servicing rights under SFAS 133. If changes in. the value of the servicing rights and the hedges meet certain hedge effectiveness criteria, changes in the fair value of the servicing rights may be offset in the income statement by changes in the fair value of the hedging instrument . Under S FAS 133, as amended, the hedges are marked-to-market through the income statement as other income.
208.
On August 31, 2006, NetBank received an initial comment letter from
the SEC Staff regarding the Company's Form 10-K for the fiscal year ended December 31, 2005 as filed on March 15, 2006. 209.
The SEC' s comment letter questioned NetBank ' s application of
Financial Accounting Standards Board Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS
133"), to the accounting of its mortgage servicing rights and loans held for sale.
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Under SFAS 133, NetBank performed its hedge effectiveness assessments using a statistical analysis approach other than regression. However, the SF..C questioned whether NetBank's method of assessing hedge effectiveness was reasonable in the circumstances and asked the Company to perform extensive supplemental analysis
to demonstrate the reasonableness ofNetBa.nk's method in comparison to a regression methodology. Although NetBank was purporting to largely exit the lines of business to which the SEC 's comment letters related , those lines formed a signi fi cant portion
of the Company 's business in 2004 and 2005 which drove, in part, the value of the Company at those times. The Individual Defendants knew that if the Company were
required to apply a different method of assessing hedge effectiveness it would necessarily require a restatement of, at least, the Company's financial results as
audited by E&Y for the years 2004 and 2005 and could spell financial ruin for NetBank. Notwithstanding the materiality of this information to investors, NetBank
failed to disclose these issues and allowed the investing public to continue to purchase and hold the stock on the belief that the Company's prior financial results were accurate.
210. Despite the severity of the potential consequences of the August 31, 2006, SEC letter and E&Y's reservations, NetBank did not reveal the existence of the -120-
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SEC letter until almost one year later on July 18, 2007. Those revelations were made long after NetBank had failed to file financial results for 2006 in the wake of E&Y's continuing refusal to re-issue its audit report covering the consolidated financial
statements of the Company for the years ended December 31, 2004 and 2005, for inclusion in the 2006 Form 10-K.
211. On July 18, 2007, NetBank filed a Form 8-K with the SEC, signed by Defendant Gross, in which it revealed for the first time that for nearly a year it had been under SEC scrutiny regarding its SFAS 133 accounting. Thus, in the Form 8-K,
NetBank revealed: On August 31, 2006, we received an initial comment letter from the SEC Staff regarding the Company's Annual Report on Form 10- K for the fiscal year ended December 31, 2005 (the "2005 Form 10-K"), to which the Company provided an initial response. Subsequently, the Company received follow-up and additional comment letters from the SEC Staff relating to the 2005 Form l0-K and the Company's Quarterly Reports on Form 10-Q for the quarters ended March 31, 2006, June 30, 2006 and September 30, 2006. The Company has provided responses to all subsequent letters. However, as of the date of this Current Report on Form 8-K, certain comments remain unresolved as the Company and the SEC Staff continue to review and discuss the Company's application of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 133, Accountingfbr Derivative Instruments and Iledging Activities ("SFAS 133"), to the accounting of its mortgage servicing rights and loans held for sale.
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212. In the same Form 8 -K, NetBank also revealed that E&Y had formally advised the Company that it would not re-issue its audit report covering NetBank's
consolidated financial statements for the years ended December 3 l , 2004 and 2005, for inclusion in the 2006 Form 10-K. E&Y also indicated that it would not re-issue such audit report for inclusion in the 2006 Form 10-K until the Company has resolved with the SEC, the SEC's comments with respect to the Company's application of
SFAS 133 to the accounting of mortgage servicing rights and loans held for sale. 213. A component of the E.&Y audit was the provisions of FAS 133 which E&Y established for NetBank in 2002. Each year, over the several years, E&Y changed their interpretation of how NetBank should comply with FAS 133, and each
time, required NetBank to conduct additional analysis of previous years' accounting before E&Y would sign off on their full-year financials. The area in question pertained to the effectiveness of NetBank's hedging against loans. 214.
In 2006, E&Y said that NetBank had to re-calculate its loan hedge-
effectiveness on a daily analysis basis for the years 2005 and 2006, long after the hedges were in place . As a result of the increasing demands by E&Y, in 2006, NetBank CEO Steve Herbert exploded during a conference with the E&Y auditors over why they wanted NetBank to change the way they complied with FAS 133 each -122-
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year. As a result of this disagreement , among other things, E&Y withdrew as
NetBank's auditors..A.l though they had been paid for the full years' 2006 audit, E&Y would not sign off on NetBank's 4" Quarter 2006 financials and would not provide their sign off for the 2006 full-year audit. X.
THE TRUTH REGARDING DEFENDANTS' FRAUD BEGINS TO EMERGE 215. The fact that Defendants had significantly misrepresented NetBank's
financial results, operations and condition in order to defraud investors did not become known on a single day. Rather, the truth about Defendants' fraud and NetBank's true financial condition began to emerge on May 21, 2007, and continued through the time of its ultimate demise, representing the largest bank failure in the
United States in 14 years and beyond. Because NetBank has not filed its audited financial statements for 2006 and E&Y has refused to re -issue its 2004 and 2005 audit report, the true extent of the fraud remains unknown. Although the truth regarding the Defendants' fraud began to emerge on May 21, 2007, the truth
regarding NetBank's deteriorating financial condition, which was a direct and proximate result of Defendants' fraud, began prior to the end of the Class Period on May 21, 2007. The truth regarding NetBank' s true financial condition emerged in a
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series of partial disclosures throughout the Class Period. For example, an aspect of
truth regarding NetBank's true condition, but not the truth of the Defendants' fraud, was partially disclosed on November 9, 2006, when the Company revealed that Ernst & Young had resigned as its auditor. Aspects of the truth about NetBank's financial
condition, but not the truth of the Defendants' fraud, were partially disclosed on February 21, 2007, when the Company announced its preliminary unaudited results
for the year ended December 31, 2006, having recorded an after-tax loss of $86.3 million or $1.86 per share during the fourth quarter. A.
First Disclosure of Regulatory Issues
216.
On May 21, 2007, NetBank issued a press release in which it announced
that it had been forced to sell. core assets, outside the context of the restructuring, in order to cover its bank deposit obligations. Yet, these assets were the very assets that NetBank's restructuring was intended to preserve. However, the sale was not
voluntary. Rather, as the Company disclosed for the first time, it had been compelled by banking regulators who "advised" NetBank management to find an "alternative" to the restructuring to shore up NetBank's "capital and earnings trends" "immediately
[to] cover all of the bank's deposit obligations."
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217.
For the
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announcement
acknowledged that many of the problems it faced were not due to the "weakened fundamentals of our core businesses." In effect, NetBank had thus revealed that its efforts to enter new business segments by leveraging its core business was a failure and that the initial appearance that that strategy had been positive was premised upon
the Company's false and misleading financial statements for the years 2004 and 2005 prepared by E&Y. Yet, even then, NetBank did not reveal that it had been under intense scrutiny from the SEC. Rather, NetBank claimed only that it had been under extreme financial pressure for more than a year mainly due to a difficult mortgage origination market and a flat yield curve. The Company claimed that those pressures resulted in large operating losses that significantly reduced the company's capital position.
218. According to a confidential witness who was a senior executive officer of NetBank during most of the Class Period, and who had direct daily contact with the top executive officers, the Defendants were aware at least as early as the time banking regulators became involved in the direction of the Company that if NetBank
could not be sold, it would fail. 219.
Despite the long overdue acknowledgment by NetBank on May 21, -125-
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2007, according to a confidential witness who was a senior corporate officer of NetBank during most of the Class Period, and who provided input directly to defendants Freeman, Herbert, and Gross, as early as the third quarter of 2006, the De.Cendants were aware that a sale of the entire Company was necessary. Accordingly, NetBank and the Individual Defendants attempted to merge or sell NetBank at least twice before the EverBank transaction was pursued. Specifically, in September, 2006, NetBank held discussions with First Horizon which quickly failed once First Horizon
conducted its due diligence of NctBank. 220. Ultimately, in response to pressure from regulators, NetBank sold, at a loss ofbettiveen $60 to $ 70 million : $2.5 billion of the Company's core and brokered deposits; NetBank's held for investment loan portfolio; all ofthe assets and liabilities of NetBank Business Finance , the Company' s small business equipment leasing and
financing operation; and the NetBank brand and related trademarks and service marks. In its May 21, 2007 press release, NetBank: announced that the bank has executed an asset purchase and liability assumption agreement with EverBank, an FDIC-insured, federal savings bank and subsidiary of EverBank Financial Corp., a privately held financial services holding company headquartered in Jacksonville, Fla., with approximately $4.7 billion in assets. The purchase price represents a discount to the current carrying value of the assets and liabilities being conveyed, and NetBank anticipates recording a loss on sale of between -126-
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$60 and $70 million at close.
The transaction is expected to close by the end of June 2007, subject to regulatory approval, and relates to the broader initiative the company began earlier in the year to consider strategic alternatives that would allow management to serve the interests of its customers, while protecting the company's equity position from continued erosion.. The company has been under extreme financial pressure for more than a year due to a difficult mortgage origination market, a flat yield curve environment and other factors. These pressures have resulted in large operating losses that have significantly reduced the company's capital. position and prompted heightened regulatory oversight.
NctBank worked closely with regulators as it evaluated various opportunities. Regulators have been increasingly concerned about the bank's capital and earnings trends and advised management to find an alternative immediately that covered all of the bank's deposit obligations.
The primary assets and liabilities in the transaction include:
The bank's held for investment loan portfolio; * All of the assets and liabilities of NetBank Business Finance, the bank's small business equipment leasing and financing operation;
* The bank's $2.5 billion in core and brokered deposits; and * The NetBank brand and related trademarks and service marks. Management Commentary
"In spite of our best efforts to improve the company's operating profile through the restructuring plan we undertook last year, our company has -127-
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remained very vulnerable and at risk due to the weakened,fundamentals ofour core businesses," said Steven F. Herbert, chief executive officer, NetBank, Inc. "Our mortgage operations continue to struggle in the face of a highly competitive marketplace, especially the third-party origination channel. Bank earnings have also fallen sharply as we have had to de-leverage the balance sheet in order to maintain risk-based capital ratios within appropriate regulatory guidelines.
"Our effort to manage and address these pressures was further complicated by the delay of the annual audit and greater day-to-day regulatory oversight and involvement.
"Our remaining businesses will include our mortgage servicing operation, along with our retail prime mortgage franchise, Market Street Mortgage," Herbert concluded. "We are actively evaluating their longterm strategic alternatives as well as those of the parent company as a whole. We have also retained our CMC claim. and the deferred tax asset that we generated in the fourth quarter of 2006. After consummation of the EverBank transaction, we will focus intensely on prosecuting the CMC sureties and pursuing our claim against them, which we now estimate at $150 million."
221.
On May 21, 2007, defendants Herbert and Gross held a conference call
with analysts to discuss the Company's shocking revelations. On the call, Defendant
Herbert stated that "We sought and were unable to successfully pursue a transaction for the entire company." He further explained that, "In the end, EverBank was the only partner that stepped up with a plan that the regulators were prepared to seriously consider." Herbert stated that after transitioning the deposit base to EverBank, the
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residual portions of the bank platform would need to be shut down at a cost of $26 million to $34 million. On the call Herbert also estimated that shareholders equity dropped to $182 million from $229 million at the end of 2006. He forecast shareholder equity would further decline to $50 million to $70 million after costs to unwind the businesses that were being shut down or sold. 222.
In response to this disastrous news, the market , shocked, reacted sharply
and swiftly. NetBank's stock price plummeted from $1.75 per share on Friday, May
18, 2007 to $0.59 per share on May 21, 2007 (the next trading day), a drop in price of over 66% on massive volume of 1 1,190,400, which was over forty-five times the
volume of the previous trading day. 223. Undeterred , Herbert continued the charade that the failure to timely file with the SEC was merely a "delay" rather than a substantive problem that threatened the very continuation of NctBank as a going concern and omitted that the Company's
accounting was under intense scrutiny from the SEC. Herbert stated: Our effort to manage and address these pressures was further complicated by the delay of the annual audit and greater day-to-day regulatory oversight and involvement.
224.
Herbert's statement remained materially false and misleading in that it
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falsely led investors to believe that the delay in filing the 2006 Form 10-K and First Quarter 2007 Form I 0-Q was not due to a substantive issue , but rather was merely the procedural result of not being able to engage an auditor in time to file. These statements omitted to state that, in fact, the reason for the failure to timely file was the failure of Defendants to comply with GAAP in valuing its core mortgage portfolio
and, through that, its tangible book value. Herbert's statements also omitted that the Company was under intense scrutiny from the SEC regarding its FAS 133 accounting, as alleged. 225.
On May 22, 2007, as reported by the Associated Press, Paul J. Miller Jr,
an analyst with Friedman, Billings, Ramsey, said the net value of NetBank's assets, which the bank then estimated at $25 million to $45 million, was "careening toward zero." Based on the Company ' s May 21 , 2007 disclosure , Miller downgraded NetBank to "Underperform" from "Market Perform" and cut his price target for NetBank's common stock from $2.00 to $0.00. Analyst Christopher Marinac of FIG
Partners LLC in Atlanta, dropped all coverage of NetBank as of that day. 226.
In response to Miller's rating and the related news article, NetBank's
stock price fell a further 37%, from $0.59 per share on May 21, 2007 to $0.37 per share on May 22, 2007. -130-
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227. According to a confidential witness who was a NetBank officer employed in the Corporate Fi Hance Department throughout the Class Period, and who had direct dealings with top management including CFE Herbert, Defendants knew that given NetBank's assets and liabilities the Company "could never close the
[F.verBan.k.] deal." 228.
In addition to the fact that the Defendants independently knew that the
EverBank merger would not close based on the economic merits, Herbert also knew that the transaction required approval by the OTS. However, at the time of Herbert's May 21, 2007 statements, the work necessary to conduct the merger had not yet
begun. According to a confidential witness who was a senior corporate officer of NetBank during most of the Class Period, and who provided input directly to
defendants Freeman, Ilerbert, and Gross, even as of June 2007 the parties were still attempting to hire project leaders for the merger. According to that confidential
witness, the merger process had not begun because the parties lacked the necessary personnel to complete the project.
229.
On the May 21, 2007 conference call, defendant Herbert effectively
conceded that a sale of the entire Company was not a viable option because of the status of the audit and lack of financials, and that simply delaying any sale was also -131-
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not an option: The OTS directed us to secure an immediate solution that enabled the bank to meet all of those deposit obligations. I think they made it pretty clear that if we did not soon resolve all the deposits , they would be obligated to step in. And I think they also made it pretty clear that they would not hesitate or delay to step in if needed.
So, we were unable to effectively pursue a transaction fi r the entire company due to the status of our annual audit. As you well know, we don't have current financials and we couldn't secure a shareholder vote because of the non-current nature of our financial statements.
So we were limited to fewer options and given the regulatory framework that I just mentioned, waiting was not an option. Delay, we believed, would have resulted in further capital erosion and probably or would have brought to bear adverse regulatory actions.
230.
Similarly, according to a confidential witness, who was a senior
executive of NetBank during the entire Class Period, and who had regular daily interaction with defendants Freeman, Herbert and Gross, it was well known to NetBank's management in March of 2007, that the Company would not survive.
Indeed, it was known and understood by the Defendants that the agreement reached with EverBank would only provide sufficient capital to enable NetBank to shut down, not to continue operations as Herbert claimed on the May 21, 2007 conference call.
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August 2007 Disclosure of Material Overvaluation
231. Long after NetBank's shocking revelations of May 21, 2007, additional aspects of the truth continued to emerge; however, the damage was done and none resulted in a material decline in the Company's stock price.
232.
On August 6, 2007, NetBank filed a Form 8-K with the SEC in which
Defendants disclosed for the first time that one of the Company's core operations,
Market Street, NetBank's wholly-owned retail mortgage business, was not only substantially overvalued in violation of GAAP, but was in fact worthless. As a result, the Company took a non-cash impairment charge of approximately $24.6 million for the impairment of goodwill assigned to Market Street where the carrying value of Market Street was exactly the amount written off -- $24.6 million.
233. In the August 6, 2007 8-K, NetBank revealed that Market Street was worthless and that its goodwill was impaired, a fact that Defendants claimed only to have discovered when examining options to dispose of that entity: Based on the information the Company obtained during the course of its consideration of such other opportunities for Market Street, and the likelihood of execution of one or more of such other opportunities, the Company determined that an event indicative of impairment had occurred with respect to Market Street.
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As a result, the Company evaluated the carrying value of goodwill of Market Street, and on August 2, 2007, authorized officers of the Company concluded that a material impairment charge with respect to the carrying value of goodwill assigned to Market Street is required under GAAP. As a result, for the second quarter ending Tune 30, 2007, the Company expects to record a non-cash impairment charge of approximately $24.6 million (both pre-tax and after tax) for the impairment of goodwill assigned to Market Street.
234.
Ina Form 8-K filed on August 6, 2007, NetBank also disclosed that the
Office of Thrift
Supervision
("OTS") had notified NetBank that it was
undercapitalized and was required to respond with a capital restoration plan no later
than September 13, 2007 that would satisfy applicable regulations . NetBank also confinned that its stock had no value and was a "highly speculative" investment: Due to NetBank's capital category and as provided in the Notice, NetBank is subject to various restrictions, including limits on (i) capital distributions; (ii) growth in total assets; (iii) acquisitions of new companies or offices; (iv) engaging in any new lines of business; and (iv) accepting, renewing or rolling over of brokered deposits.
As aresult ofthe Company's obligations under the Notice, the Company believes that its outstanding common stock may have little or no value. Accordingly, investment in the Company's common stock would be highly speculative.
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235. As ofAugust 7, 2007, having confrm.ed what many investors recognized as a result of NetBank ' s shocking revelations on May 21 , 2007 - that NetBank's
outstanding common stock had little or no value and that any investment in the stock. would be highly speculative - the jig was finally up. Indeed, NetBank's August 6, 2007 Form 8-K also disclosed that the NASDAQ, likely recognizing NetBank's
assurances that it would ultimately file its long awaited financial reports [or the farce that they were, intended to delist the Company's common stock due to its continued failure to file its 2006 Form 10-K, which NetBank had promised the investing public as of June 30, 2007, and the First Quarter 2007 Form 10-Q. After NetBank's
purported June 30, 2007 target date passed, its August 6, 2007 Form 8-K was the final confirmation that the Company could no longer continue the charade and that its late filings were, in fact, the result of the Defendants ' failure to properly vat ue NetBank's core businesses in accordance with GAAP.
236.
On August 7, 2007, NetBank reiterated that despite the fact that it
expected to receive $19.25 million from the settlement of long standing litigation, the Company reiterated its August 6, 2007 warning that Netbank common stock was
worthless.
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237. On this news, NetBank's stock price doubled from $0.06 per share on August 22, 2007 (on volume of 34,089 shares) to $0.12 per share on August 23, 2007 (on astounding volume of 6,294,574 shares). 238.
The statements set forth in the above subsection were materially false
and misleading because, in combination with the proposed sale of assets to EverBank, this cash infusion falsely led investors to believe that the Company could now be in
compliance with OTS requirements. C.
The Disclosure of the Collapsed Everbank Agreement
239.
On September 17, 2007, EverBank issued a press release in which it
announced: "that it ha[d] terminated its agreement to acquire NetBank's consumer deposit accounts, business finance division and other assets under the transaction announced on May 21, 2007, This decision comes after it became clear that NetBank would not be able to complete certain conditions required to close and receive regulatory approval." 240. NetBank's September 17, 2007 Form 8-K filed with the SEC announcing the termination of the agreement stated that: On September 14, 2007, the Bank received a letter from EverBank notifying the Bank of EverBank's termination of the Purchase -136-
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Agreement effective on September 14, 2007. EverBank's letter states that NetBank is in breach of its representations and warranties as the basis for its termination of the Purchase Agreement.
EverBank has not advised the Bank or the Company of any specifics regarding the alleged breach. The Company and the Bank do not believe that any breach has occurred. However, since the required regulatory approvals were not received by August 3I, 2007, and since the Purchase Agreement permits either party to terminate the Purchase Agreement without cause after that date, neither the Company nor the Bank presently contemplate contesting the termination. Instead the Company intends to pursue such other strategic alternatives as may be available.
As a result of ongoing Financial and regulatory pressure, the Company believes that its outstanding common stock may have little or no value. Accordingly, investment in the Company' s common stock would be highly speculative.
241.
On September 28, 2007, NetBank, Inc. filed a voluntary petition for
relief under Chapter 1 I of the United States Bankruptcy Code in the United States Bankruptcy Court for the Middle District of Florida, Jacksonville Division. The Company announced that it would continue to operate as a debtor-in-possession under the jurisdiction ofthe Bankruptcy Court. NetBank's failure represented the first
bank failure in five years, the largest ever in the State of Georgia and the largest in the preceding 14 years. 242. On September 28, 2007, NetBank also announced that the Office of -137-
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Thrift Supervision exercised its authority under applicable federal law to appoint the Federal Deposit Insurance Corporation as receiver for NetBank, a federal savings
bank and a wholly- owned subsidiary of the Company. 243.
In a September 28, 2007, press release, the OTS explained that:
The Office of Thrift Supervision (OTS) announced today that it closed $2.5 billion NetBank, headquartered in Alpharetta, Georgia, and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. A`etBank sustained s ignificant losses in 2006 primarily due to early payment defbulis on loans sold, weak underwriting, poor documentation , a lack ofproper c ontrols, and failed business strategies. As a result, the OTS executed a formal enforcement action with NetBank in 2006 directing the institution to correct its operating deficiencies and enhance its capital position . While the institution continued to operate in excess of minimum capital standards , the actions taken to address these problems were unsuccessful and it became clear that high operating expenses combined with continuing losses were jeopardizing the institution ' s viability.
In response, NetBank's board of directors undertook efforts to complete a private sale of the institution. These efforts were unsuccessful and the institution had no remaining prospects for raising capital and achieving profitability. Accordingly, the OTS exercised its authority under the Home Owners' Loan Act to appoint the FDIC as receiver of the institution.
244. That same day, Eula L. Adams resigned as a member of the Board of
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Directors, of the Company. Mr. Adams' resignation was reportedly "not due to any disagreement with the Company." Adams also resigned as a member of the Audit Committee and Corporate Governance Committee of the Board effective September 28, 2007. 245. On October 1, 2007, EverBank announced that it successfully acquired approximately $700 million of NetBank mortgage assets. XX..
GAAP VIOLATIONS 246. As described above, the Defendants caused the Company to falsely
report its financial position and results of operations throughout the Class Period by,
among other things, overstating net earnings (or understating net losses, as applicable) and misrepresenting the Company's true financial position. The Company's 2004 and 2005 annual financial statements and. 2006 interim financial statements for the first, second and third quarterly periods (collectively, the "relevant financial statements") were not a fair presentation of the Company's financial position and results of operations , and were not presented in conformity with GAAP
and SEC rules. 247.
Generally Accepted Accounting Principles ("GAAP") are those
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principles recognized by the accounting profession as the conventions, rules, and procedures necessary to define accepted accounting practices at a particular time. GAAP principles are the official standards accepted by the SEC and promulgated in part by the American Institute of Certified Public Accountants ("AICPA"). GAAP consists of a hierarchy of authoritative literature . The highest priority is comprised of Financial Accounting Standards Board ("FASB") Statements of Financial .Accounting Standards ("FAS"), followed by FASB Interpretations ("FIN"), Accounting Principles Board Opinions ("APB"), and AICPA Accounting Research Bulletins ("ARB"). GAAP provides other authoritative pronouncements including,
among others , the FASB Concept Statements ("FASCON"). 248. As a publicly traded company during the Class Period, NetBank was responsible for and required to maintain books and records in sufficient detail to reflect the transactions of the Company and, therefore, prepare financial statements in accordance with GAAP. Specifically , the Exchange Act, 15 U.S.C. § 78m (b) (2),
requires public companies to: (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
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(B) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that -
transactions accordance are executed in management's general or specific authorization;
249.
with
H.
transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and
iii.
to maintain accountability for assets;
iv.
access to assets is permitted only in accordance with management's general or specific authorization; and
V.
the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.
SEC Regulation S-X (17 C.F.R. § 210.4-01(a)(1)) states that financial
statements filed with the SEC which are not 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 comply with
GAAP, with the exception that interim financial statements need not include disclosure which would be duplicative of disclosures accompanying annual financial
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statements . (17 C.F.R. § 210.10-01(a)). A.
Lack of Ade uate Internal Controls
250.
Despite repeated certifications
and other public statements by
Defendants as alleged more fully herein, NetBank lacked effective disclosure controls and procedures, and internal control over financial reporting. Absent proper controls and procedures, the resulting Financial reporting may be materially false and
misleading . Indeed, NetBank's lack of adequate controls was so profound and irreconcilable, the Company's independent auditor, E&Y, resigned effectively in
protest over this issue in. November 2006. 251. NetBank's 2004 Form 10-K, filed with the SEC on March 16, 2005 -the opening of the alleged Class Period, reported that the Company's internal controls
had been found to be deficient, but assured investors that such deficiencies had been corrected and would not recur: Management's Conclusion on the Effectiveness of Disclosure Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer, along with other management of the Company, reviewed and evaluated the Company's disclosure controls and procedures (as defined in rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the -142-
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"Exchange Act")) as of December 31, 2004. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer of the Company concluded that, as of December 31, 2004, the disclosure controls and procedures in place at the Company were not effective due to a material weakness in its internal control over financial reporting related to the estimation of the change in fair value of the Company's portfolio of mortgage loan funding commitments for which the interest rate is locked ("rate locks") which constitute derivative financial instruments as defined by Statement of Financial Accounting Standards No. 133 ("SFAS 133"), Accounting for Derivative Instruments and Hedging Activities, as amended by Statement of Financial Accounting Standards No. 149 ("SFAS 149"), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The error would have resulted in an overstatement ofthe mark-to-market of the derivatives which is included in the gain on sale line item.
Due to this material weakness, the Company, in preparing its financial statements at and for the year ended December 3 t, 2004, performed and implemented the additional procedures discussed below under the heading "Other Control Matters" to strengthen its controls and procedures over the process. Due to the nature of the material weakness and the additional procedures implemented, management believes the circumstances which resulted in the error will not recur.
252. In that same 2004 Form 10-K, Defendants admitted their responsibility for the Company's financial internal controls and further explained: Management's Annual Report on Internal Control over Financial Reporting
The management of NetBank is responsible for establishing and maintaining adequate internal control over financial reporting (as -143-
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defined in Rule 13a-15(f) under the Exchange Act). NctBank's internal control system is designed to provide reasonable assurance to the Company's management and Board of Directors regarding the preparation and fair presentation of published financial statements.
An internal control material weakness is a significant deficiency, or aggregation of deficiencies, that does not reduce to a relatively low level the risk that material misstatements in financial statements will be prevented or detected on a timely basis by employees in the normal course of their work. An internal control signilcant deficiency, or aggregation of deficiencies, is one that could result in a misstatement of the fnancial statements that is more than inconsequential.
The management of NetBank assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2004, and this assessment identified a material weakness in the Company's internal control over financial reporting related to its controls over the determination and estimation of the change in fair value of the Company's portfolio of mortgage loan funding commitments where the interest rate has been locked and related financial derivatives. Changes in such fair value are recorded to gain on sales of loans and to other assets or other liabilities. As a result of this material weakness, the Company had overstated its gain on sales of loans and recorded an adjustment in the December 31, 2004 financial statements to correct this error.
In making its assessment of internal control over financial reporting management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Because of the material weakness described in the preceding paragraph, management believes that, as of December 31, 2004, the Company's internal control over financial reporting was not effective based on those criteria.
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253.
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In that same 2004 Form 10-K, Defendants included a letter dated March
11, 2005 from NetBank's independent auditor, E&Y to the NetBank Board and the Company's shareholders, which stated in pertinent part: Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
The Board of Directors and Shareholders of NetBank, Inc.
We have audited management's assessment, included in the accompanying Management's Annual Report on Internal Control over Financial Reporting, that NetBank, Inc. did not maintain effective internal control over financial reporting as of December 31, 2004, because of the effect of a material error that was not identified by NetBank, Inc.'s internal control over financial reporting, based on criteria established in Internal Control----Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). NetBank, Inc.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and. an opinion on the effectiveness of NetBank, Inc.'s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, -145-
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evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
A company's internal control over financial reporting includes those policies and procedures that (l) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures o Fthe company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management's assessment. There were insufficient controls over the determination and estimation ofthe change in fair value of the Company"s portfolio of mortgage loan funding commitments where the interest rate has been locked and the related financial derivatives. As a result of this material weakness in internal -146-
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control, NctBank, Inc. concluded that the amount of gain on sales of loans was overstated and recorded an adjustrn.ent to correct this error. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2004 financial statements, and this report does not affect our report dated March 11, 2005 on those financial statements.
In. our opinion, management's assessment that NetBank, Inc. did not maintain effective internal control over financial reporting as of December 31, 2004 is fairly stated, in all material respects, based on the COSO control criteria. Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, NetBank, Inc. has not maintained effective internal control over financial reporting as of December 31, 2004 based on the COSO control criteria.
254.
In that same 2004 Form 10-K, Defendants also included a response as
to the identified material control weakness and provided these additional assurances to investors: In response to the material control weakness discussed above in Management's Annual Report on Internal Control over Financial Reporting, management has taken the following steps to remediate the control weakness:
•
The necessary data and information for estimating the initial and ending fair values are now accumulated within a single department;
•
Analytics are now being prepared which compare the changes in
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fair value to changes in the fair value of offsetting hedges and general changes in interest rates to ensure results are reasonable;
The Company's corporate controller is now required to review the process and associated analysis.
Management will continue to closely monitor the changes implemented to ensure their effectiveness. Except for the changes discussed above, there were no other changes in the Company's internal control over financial reporting that have materially effected, or are reasonably likely to materially effect, its internal control over financial reporting. 255.
Similarly, the Company's Forms 10-Q for the first, second and third
fiscal quarters of 2005 (filed with the SEC on May 10, August 9 and November 14, 2005, respectively ) repeated Defendants " assurances that the Company' s controls were operating effectively. In addition , each of those financial reports purported to report the Company's financial condition as of the end of the respective fiscal quarter
and financial results for the fiscal quarter. 256. NetBank's 2005 Form 10-K, filed with the SEC on March 15, 2006 again reported that the Company's internal controls had been found to be effective: Management's Conclusion on the Effectiveness of Disclosure Controls and Procedures
Evaluation of Disclosure Controls and Procedures. We evaluated the
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effectiveness of the design and operation of our "di.sclosure controls and procedures," as defined in Rule 13a-15(e) under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this report. This evaluation was done under the supervision and with the participation of management, including our chief executive ofl:icer ("CEO") and chief finance executive ("CFO"). x;E ;r^C
Objectives of Controls. Disclosure controls and procedures are designed so that infonnation required to be disclosed in our reports filed under the Exchange Act, such as this Annual Report on Form 10-K, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Conclusions. Based upon the disclosure controls and procedures evaluation, our CEO and CFO have concluded that as of December 31, 2005, our disclosure controls and procedures are effective to provide reasonable assurance that the foregoing objectives are achieved.
Changes in internal Control over Financial Reporting. There were no changes in our internal control over Financial reporting, as defined in Rule 13a-15(t) under the Exchange Act, during the quarter ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
257.
In that same 2004 Fonn 10-K, Defendants admitted their responsibility
for the Company's financial internal controls and further explained:
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Management's Annual Report on Internal Control over Financial Reporting
The management of NetBank is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
Management, under the supervision and with participation of the CEO and CFO, has assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on management's assessment and that criteria, management concludes that, as of December 3 1, 2005, the Company's internal control over financial reporting is effective.
258. In that same 2005 Form 10-K, Defendants included a letter dated March 13, 2006 from NetBank's independent auditor, E&Y to the NetBank Board and the Company's shareholders, which stated in pertinent part: Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
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We have audited management's assessment, included in the accompanying Management's.Annual Report on Internal Control over Financial Reporting, that NetBank, Inc. maintained effective internal control over financial reporting as of December 3 I , 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). NetBank, Inc.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed. to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with -151-
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generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Tn our opinion, management's assessment that NetBank, Tnc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, NetBank, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of NetBank, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2005 and our report dated March 13, 2006 expressed an unqualified opinion thereon.
259. On April 10, 2006, NetBank issued a press release via Business Wire which stated in pertinent part that the Company: [NetBank] is currently implementing the FRS RiskResolve solution as the foundation of its Sarhanes-Oxley (SOX) compliance strategy. The diversified financial services provider will utilize RiskResolve to automate SOX testing and attestation in a single application in order to streamline its compliance efforts and achieve greater transparency across the enterprise. NetBank will also extend its use of the FRS solution beyond compliance to enterprise operational risk management (EORM) -152-
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during the next phased deployment of RiskResolve to the business unit owners. Risk.R.esolve`s automated COSO approach will enableNetBank to align risk assessments, controls and actions to its reporting procedures throughout the organization and establish compliance and operational risk management as sustainable business processes.
"The RiskResolve deployment is an important element of our on-going SOX compliance strategy," said Joyce Bellows, Director of SOX and Internal Controls, NetBank, Inc. "We believe that the solution is uniquely qualified to give us unprecedented insight into our business processes and risk scenarios, and to help ensure that our financial reporting and disclosures are accurate and complete."
260.
Similarly, the Company's Forms 10-Q for the first, second and third
fiscal quarters of 2006 (filed with the SEC on May 10, August 8 and November 9,
2006, respectively) repeated Defendants' assurances that the Company's controls were operating effectively. In addition, each of those financial. reports purported to report the Company's financial condition as of the end of the respective fiscal quarter
and financial results for the fiscal quarter. 261.
E&Y's resignation as NetBank's independent auditor became effective
on November 9, 2006. Despite the representations of NetBank and E&Y, the Company had a significant ongoing disagreement with NetBank regarding the
calculation of the Company's hedge effectiveness under FAS 133. Acknowledging the weakness in its internal controls, NetBank revealed that E&Y had resigned, at -153-
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least in part, because of the "the determination. and estimation of the change in fair value of the Company's portfolio of mortgage loan funding commitments where the
interest rate had been locked ." NetBank also reported that (emphasis added): "[i]n 2005, the Company implemented certain changes to its internal controls to address the material weakness over the Company's rate locks and determined that the
material weakness existing at December 31, 2004 was corrected." 262.
NetBank's Form 8-K, filed November 9, 2006, which reported the
resignation of E&Y as the Company's auditor, also reported: In the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004, which the Company Filed with the SEC on March 16, 2005, Management's Annual Report on Internal Control over Financial Reporting stated, and E&Y's report on internal controls reiterated, that because of the material weakness disclosed in those reports, the Company's internal control over Financial reporting was not effective as of December 31, 2004, based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. The material weakness in those reports concerned the Company's controls over the determination and estimation of the change in fair value of the Company's portfolio of mortgage loan funding commitments where the interest rate had been locked and the related financial derivatives ("rate locks"). In 2005, the Company implemented certain changes to its internal controls to address the material weakness over the Company's rate locks and determined that the material weakness existing at December 31, 2004 was corrected. 263.
On February 21, 2007, NetBank issued a press release via Business Wire,
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in which it claimed that: The company currently believes that the 2006 audit, and related auditor attestation regarding the company's internal control over financial reporting, will be completed in June 2007 and expects to file its Annual Report on Form l 0-K for the 2006 fiscal year with the SEC on or before June 30, 2007, although no assurance can be given.
264.
On March 23, 2007, NetBank issued a press release via Business Wire,
in which it repeated certain statements regarding its internal controls contained in a press release issued by the Company on February 21, 2007, reporting in pertinent part
that: The company currently believes that the 2006 audit, and related auditor attestation. regarding the company's internal control over financial reporting, will be completed in June 2007 and expects to file its 10-K with the SEC on or before June 30, 2007, although no assurance can be given.
265. E&Y' s sentiments were echoed by the SEC. On July 17, 2007, NetBank revealed that beginning nearly a year earlier, on August 31, 2006, the Company had begun to receive a series of letters from the SEC challenging the Company's application of Financial Accounting Standards Board Statement of Financial
Accounting Standards No. 133, Accountingfor Derivative Instru ments and Hedging Activities ("FAS 133"), to the accounting of its mortgage servicing rights and loans
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held for sale. Specifically, NetBank revealed for the first time that nearly a year earlier: On August 31, 2006, we received an initial comment letter from the SEC' Staff regarding the Company's Annual Report on Form 10- K for the fiscal year ended December 31, 2005 (the "2005 Form 10-K"), to which the Company provided an initial response. Subsequently, the Company received follow-up and additional comment letters from the SEC Staff relating to the 2005 Form I 0-K and the Company's Quarterly Reports on Form 10-Q for the quarters ended March 3 1, 2006, June 30, 2006 and September 30, 2006. The Company has provided responses to all subsequent letters. However, as of the date of this Current Report on Form s-K, certain comments remain unresolved as the Company and the SEC Staff continue to review and. discuss the Company's application of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 133, Accounning for Derivative Instruments and.HedgingActi vities ("SFAS 133"), to the accounting of its mortgage servicing rights and loans held for sale.
266.
E&Y refused to re-issue its audit opinion for inclusion in NetBank's
2006 Form 10-K until the Company resolved the SEC's issues with respect to the Company's application oIFAS 133 related to the accounting of mortgage servicing
rights and loans held for sale. E&Y's refusal likely prompted NetBank's July 17, 2007 revelations. More that one year later, at the time of its collapse on September 28, 2007, NetBank still had not - nor has it ever -- resolved the SEC's issues or filed audited financial results for 2006.
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On September 27, 2007, The Wall Street Journal reported that the
collapse of NetBank was the largest U.S. banking failure in 14 years, observing in sum that weak underwriting, a lack of internal controls and a late push into subprime mortgage lending was the simple recipe for failure. 268.
Ultimately, on September 28, 2007, the OTS announced in a press
release that it had taken the extraordinary act of closing NetBank and appointed the Federal Deposit Insurance Corporation (FDIC} as receiver, explaining that (emphasis
added): NetBank sustained significant losses in 2006 primarily due to early payment defaults on loans sold, weak underwriting, poor documentation, a lack ofproper controls, and failed business strategies.
269. NetBank's lack of effective internal controls was also specifically cited by in the OIG Audit Report as having led to the huge mortgage losses suffered by the Company, which was in turn one of the significant causes of NetBank' s failure: Ineffective Internal Controls Over Operations
Certain internal controls overNetBank's operations were ineffective. For example, rather than monitoring or instituting triggers to curtail its mortgage banking operations when economic conditions warranted such restrictions, NetBank's strategy continued to emphasize increased loan production, accomplished by lowering underwriting and documentation
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standards. Products such as "low-doe" and "no-doc" loans allowed borrowers to obtain loans without demonstrating their ability to repay the loan. In addition, underwriters reported to individuals who marketed and sold loans, and sales personnel pressured underwriters to approve loans.
Lowered underwriting standards led to poor loan quality, which led to loan repurchases, which led to large losses. In 2006, NetBank repurchased $ 1.82 million in loans that it had sold and ultimately booked $78 million dollars in loss provisions associated with the repurchases. The large losses resulting from loan repurchases significantly contributed to NctBank's failure.
270.
The responsibility for preparing the financial statements in conformity
with GAAP lies with the company's management. Specifically , defendant Herbert as NetBank's CFE and CEO, at times relevant during the Class Period, was directly responsible for ensuring that NetBank's financial statements were prepared in conformity with GAAP. Similarly, as CEO of the Company at times relevant during
the Class Period, defendant Freeman was also responsible for. ensuring that NetBank's financial statements were prepared in conformity with GAAP. 271. AICPA Auditing Standards § ("AU") 110
Responsibilities and
Functions of f the Independent Auditor ("AU 110"), in relevant part, mandates
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The financial statements are management's responsibility .... Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, initiate, authorize, record, process, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements. The entity's transactions and the related assets, liabilities, and equity are within the direct knowledge and control of management.. ..Thus, the fair presentation of financial statements in conformity with generally accepted accounting principles is an implicit and integral part of management's responsibility.
(AU 110.03) (Footnote omitted.) 272.
As alleged herein, prior to and throughout the Class Period, Defendants
caused NetBank to significantly expand. its involvement with non-conforming and other non-traditional loans relative to its core business (subsequently "other nontraditional" loans). NetBank"s expansion into the non-conforming and other nontraditional loan markets, paired with materially inadequate and ineffective controls
and underwriting guidelines, exposed the Company to a significant concentration of inherently high risk loans. That concentration, in combination with certain prevailing market conditions, such as declining home values and increasing credit delinquencies and defaults, impaired the Company's financial position and caused significant declines in the Company's results of operations during the Class Period. However, NetBank failed to timely recognize material known losses (i.e., impairments)
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regarding significant increases, primarily because ofthe Company's exposure to nonconforming loans, of certain liabilities relevant financial statements. 273. In addition to NetBank's failure to timely recognize material known impairments, the Company's relevant financial statements also failed to timely recognize known impairment losses regarding its non-conforming and other non-
traditional loan operations. 274.
In addition to NetBank' s failure to timely recognize material known
impairment losses, as alleged above, the Company's relevant financial statements also significantly overstated the value of certain n ort gage -related assets. As a result, NetBank failed to timely recognize the losses related to the overstatement ofthe value of certain of its mortgage related assets. The effect of NetBank's failure to recognize
known material impairment losses and the overstatement of its mortgage related assets artificially inflating net earnings. 275.
As a result of the foregoing, NetBank lacked effective disclosure
controls and procedures, and internal control over financial reporting, despite repeated certifications of certain Defendants and other statements to the contrary. 276. Further, the Company's relevant financial statements presented the
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Company's financial position and results of operations in a manner which, among other things, also violated the following fundamental accounting principles: (a) 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, credit and similar decisions (I ASCON 1, ¶34); (b) The principle that financial reporting should provide information about the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change resources and claims to those resources (FASCON 1, ¶40);
(c) The principle that financial reporting should provide information about an enterprise' s financial performance during a period. "investors and creditors often use information about the past to help in assessing the prospects of an enterprise . Thus, although investment and credit decisions reflect investors ' and creditors ' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance." (FASCON 1, ¶42);
(d) The principle that financial reporting should. provide information about how management of an enterprise has discharged its stewardship responsibility to owners (stockholders) for the use of enterprise resources entrusted to it. "To the extent that management offers securities of the enterprise to the public, it voluntarily accepts wider responsibilities for accountability to prospective investors and to the public in general." (FASCON 1, ¶50);
(e) The principle that financial reporting should be reliable in that it
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represents what it purports to represent. That information should be reliable as well as relevant is a notion that is central to accounting (FASCON 2, ¶J58-59);
(f) The principle of completeness , which means that nothing material is left out of the information that may be necessary to ensure that it validly represents underlying events and conditions (FASCON 2, ¶79);
(g) The principle that financial reporting should be verifiable in that it provides a significant degree of assurance that accounting measures represent what they purport to represent (FASCON 2, ¶81); and
(h) The principle that conservatism be used as a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered . (FASCON 2, ¶¶95, 97). 277. Each of the improper accounting practices , misrepresentations and omissions engaged in by Defendants , and discussed further herein, standing alone,
was a material breach of GAAP and/or SEC regulations. B.
Understatement of Representations and Warranties Liability
278. Defendants caused the Company to issue the relevant financial statements, which failed to timely recognize known losses regarding significant increases of certain liabilities - primarily because of the Company's exposure to nonconforming loans.
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According to a confidential witness, who was a senior executive of
Netl3ank during the entire Class Period, and who had regular daily interaction with defendants Freeman, Herbert and Gross, defendants Herbert and Gross, at a minimum, knew that the Company's underwriting guidelines were insufficient. As a result, the reserves that NetBank knew or should have know were necessary, were not
established. Prior to 2005, NetBank's trend analysis for the previous 8-9 years showed that the Company's reserves needed to be in the range or I and -3) basis points.
However, beginning as early as 2005, NetBank's analysis changed dramatically, showing that the Company needed to increase its reserves to between 12 and 14 basis
points. 280.
The
NetBank Regional
Operating
Center
(ROC)
handled
the
underwriting of the subprime loans for Meritage. Decisions for the sub-prime underwriting were made by Doug Freeman, Russell Burdsall, NetBank Head of Mortgage Operations , and William (Micky) Ross, the NetBank Chief of Sales and Fulfillment. By early 2006, it became clear that the Meritage subprime lending was
heading in the wrong direction and as a result, the financial position of NetBank was so severely damaged that the Company was facing the threat of breaching the
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agreement with the OTS. 281. Notwithstanding the Defendants' knowledge that NetBank's own analysis indicated that its reserves were severely deficient, on August 3, 2005, Defendant Herbert represented in a conference call with analysts: "I mean as soon we
become aware of a loan in a problem, we allocate reserves to it, based upon our expected sales price." 282.
As early as November 14, 2005, Defendant Freeman attempting to
distance the troubled loans at NetBa.nk from those in the industry, but recognizing that the risks to lenders such as NetBank were increasing, stated that: SY JACOBS: [I]s there any consistency between this group of loans we're talking about, the $3.5 million and then the smattering of other buybacks are having to do -- is there some industry trend developing here where there is an increase in fraud and loan buybacks, and they have to do with the petering out of the housing boom?
DOUG FREEMAN: There are no relationships between the processdriven ones and this group of loans, but I will tell you that T think the risk profile in the mortgage business is going up -- me and everybody else in the industry has a lot of writings on that.
283.
Similarly, during the same call, Herbert stated:
There are specific products that can cause a problem from time to time, but a lot of what we're seeing in the industry now is that the whole loan -164-
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buyers, which this was not the common practice for them are now going through some changes, we believe, anyway, and becoming more aggressive about putbacks.
We do feel that the current assumption set that we have, you know, as we look at recent behaviors, more recent frequency behaviors, that the frequency assumptions that we're making concern in the future are much more consistent with recent experience and have sort of lined up and trued up with them so we feel, in general, better about the overall level of the reserves that we have and the probability that it will be more predictive of the future than it's been here in the past several quarters.
284.
Despite Freeman's acknowledgment of the increased risks in the
mortgage business, NetBank failed to adjust its reserves and risk management to compensate. 285. At the same time, in addition to their stated belief in the increased risks, according to a confidential witness who, during most of the Class Period, was senior managerial executive of Meritage, the Defendants were aware of certain difficulties with subprime mortgage underwriting guidelines which resulted in NetBank taking
back mortgages that it should not have been accepting. 286.
The Company described its representations and warranties liability in the
Business section and Management ' s Discussion and Analysis of Financial position and Results of Operations section ("MD&A") of its Form 10-K filed March :l 5, 2006 -165-
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("2005 Form 10-K"), as follows: We make representations and warranties in the ordinary course of business to purchasers and insurers of our mortgage loans and the purchasers of our mortgage servicing rights regarding compliance with laws, regulations and program standards and as to accuracy of information. We may become liable for certain damages or may be required to repurchase a loan if there has been a breach of representations or warranties. For example, for certain loan sale agreements, we are liable to the purchaser ofthe loans ifan underlying borrower defaults on the first payments due or if the borrower prepays the loan shortly after sale. (2005 Form 10-K p. 38) (Emphasis added.)
The majority of our non-performing loans held for sale consist of loans which the Company has been required to repurchase under representations and warranties provided to purchasers of our loans. Once a loan has been repurchased, it is generally resold at a loss. Upon repurchase, the Company transfers reserves from its liability for representations and warranties to a valuation reserve for repurchased loans to record such loans at estimated net realizable value. (2005 Form I OK p. 58) (Emphasis added.) 287.
GAAP, specifically, FAS 140, Accountingfor Transfers and Servicing
of Financial Assets and Extinguishinents of Liabilities (a replacement of FASB
Statement No. 125) ("FAS 140"), required the Company to recognize liabilities incurred in the sale of its loans at fair value . FAS 140 provides , in relevant part: Upon completion of a transfer of assets that satisfies the conditions to be accounted for as a sale..., the transferor (seller) shall:
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Derecognize all assets sold
b.
Recognize all assets obtained and liabilities incurred in consideration as proceeds ofthe sale, including cash, put or call options held or written ( for example, guarantee or recourse obligations), forward commitments ( for example, commitments to deliver additional receivables during the revolving periods of some sccuritizations ), swaps (for example, provisions that convert interest rates from fixed to variable ), and servicing liabilities, if applicable...
C.
Initially measure at fair value assets obtained and liabilities incurred in a sale... or, if it is not practicable to estimate the fair value of an asset or a liability, apply alternative measures...
d.
Recognize in earnings any gain or loss on the sale.
The transferee shall recognize all assets obtained and any liabilities incurred and initially measure them at fair value (in aggregate, presumptively the price paid). (FAS 140 ¶1 l) (Certain emphasis in original and certain emphasis added.) (Footnote omitted.)
288. NetBank had an inventory of mortgages for which they maintained servicing rights which was handled by the NetBank Treasury Group. In most cases, NetBank's prime mortgages were sold to Fannie Mae and NetBank earned money by retaining the servicing rights. Under FAS 133, NetBank was required to show its
hedge effectiveness and performed calculations in an attempt to do so. However,
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according to a confidential witness who was a senior executive ofNetBank during the entire Class Period and who had regular daily interaction with defendants Freeman, Herbert and Gross, E&Y advised NetBank and its senior management that the Company's hedge effectiveness testing under FAS 133 was not being conducted frequently enough to be reliable and directed NetBank to perform the hedge-
effectiveness on a daily basis. E&Y also directed NetBank to re-calculate the hedgeeffectiveness for previous years back to 2002. 289. According to a confidential witness, who was a senior executive of NetBank during the entire Class Period, and who had regular daily interaction with defendants Freeman, Herbert and Gross, NetBank was also in negotiations with the SEC regarding the frequency with which it performed its hedge-effectiveness under
FAS 133. Ultimately, NetBank reached an agreement with the SEC in which the SEC would permit NetBank to perform a re-calculation for one month out of each quarter
to demonstrate that the hedging was effective. However, E&Y refused to accept the proposal claiming that it did not believe that it was adequate. For its part, NetBank and its senior management, upon information and belief, refused to accept the assessment of E&Y. On that basis, among others, E&Y resigned as the NetBank auditors. -168-
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290.
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FAS 5, A ccounting for Continge ncies ("FAS 5 "), provides further
guidance regarding recognition of loss contingencies. FAS 5 provides, in relevant part: For the purpose of this Statement, a contingency is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (hereinafter a "gain contingency") or loss (hereinafter a "loss contingency") to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur. Resolution of the uncertainty may confirm the acquisition ofan asset or the reduction of a liability or the loss or impairment of an asset or the incurrence of a liability. (FAS 5 ¶1) (Footnote omitted.)
An estimated loss from a loss contingency (as defined in paragraph 1) shall be accrued by a charge to income if both of the following conditions are met:
a.
Information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss.
b.
The amount of loss can be reasonably estimated. (FAS 5 ¶8) (Emphasis added.) (Footnotes omitted.)
29 1. Defendants
failed to adequately consider known breaches of
representations and warranties and the related losses that were both probable and
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reasonably estimable. As noted in the Company's 2005 Form 10-K and excerpted above, the amount of the Company's repurchase obligation, and corresponding losses, related to representations and wan-antics was in part dependent upon the amount of early defaults . As of the establishment of the representation and warranties liability at time loan sales, and subsequently, Defendants were aware, or should have been aware, of the significant probability of substantive early defaults because the Defendants were aware, or should have been aware, of the poor, and continually deteriorating, credit quality of the non-conforming loans sold as Defendants originated. or purchased, presumably following appropriate due diligence, such nonconforming loans. As discussed in greater detail elsewhere herein, Defendants were aware, or should have been aware, of certain prevailing market conditions, such as
declining home values and increasing credit delinquencies and defaults , which further increased the probability of early defaults. Defendants were aware, or should have been aware , that the Company's lax underwriting guidelines exposed the Company
to the significant probability of additional breaches of its representations and warranties regarding the loans sold which were originated by the Company. 292. Defendants disregarded such indications of the Company's true losses regarding its representations and warranties liability; however, Defendants were -170-
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aware of increasing losses as early as 2003. The Company's representations and warranties liability at the initial purchase of its non-conforming loan operations (part of the Resource acquisition as discussed in greater detail elsewhere herein) was determined to be inadequate in the year immediately following the year of the acquisition. In the Company's 2003 Form 10-K, filed with the SEC March 1.2, 2004, Defendants disclosed that the purchase price allocation had to be adjusted for additional representations and warranties liability. The 2003 Form 10-K reported: The Company recorded a $2.9 million purchase accounting adjustment due to certain pre-acquisition contingencies related to representations and warranties related to loans sold by Resource to third party purchasers prior to its acquisition by the Company. (2003 Form 10-K p. 85) 293.
On May 4, 2005, defendant Herbert assured the investing public that the
Company had done so: JOT IN HACKETT: That's sufficient for me. Thanks. With respect to the loan loss provision, you referred to some of the provisions from the dealer services that just as the portfolio matures. In the press release, it looks like you referred to some height provision expenses in the nonprime, nonconforming market. Can you give us a little more color on that? Was there some credit going on in the mortgage side?
STEVE HERBERT: Yes. For the past three quarters what we are doing there, we are really providing far what is called FIN 45 reserves. That's life -- every time we sell a loan, there is a possibility that it will be put -171-
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back due to standard reps and warranties, either for fraud or for basically early payment default.
There are really two components to that long-teen calculation. One is the frequency with which you will have to repurchase those loans, and one is the severity. All our analysis continues to consolidate at a very stable overall severity level. We feel very, very comfortable from the over 6-7 year's worth of data that we know what on average we are going to lose on those loans.
What we have seen in the last three quarters is an increase in the frequency early in the life cycle of certain vintages ofproducts. That sort of begs the question of will the fully seasoned frequency ofrepurchases be higher because the early repurchase activity is higher than what we have seen in the past or is the industry getting better at putting loans back faster?
We do have some terminal points on the overall repurchase timelines, but the bottom line is we have seen trends that have caused up to increase, not the severity levels, but our expected cumulative frequency expectations and we've made the necessary adjustments through provision expense to put reserves out there for that. We are, and do believe, that those numbers will stabilize in the future. We don't know whether that has already happened or whether it will happen next quarter or two quarters forward, because of the process we use we can't tell you for sure when that will be. We can tell you that our process is responsive to the data as it comes in and we are continuing to do some analysis there to get at some of the root causes of what, where these repurchases are coming from. 294.
Later in that same conference call, Freeman reassured the investing
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We are experiencing some decent growth in the bank. We do pay a dividend. We still have MNA obligations to build out our transaction processing business and we still like the investment in our stock around value, so all I can tell you is we try very hard to strike a balance between all of those initiatives that we have underway.
295. On August 3, 2005, during a conference call with analysts, Defendant Freeman again assured the investing public of the reliability of NetBank's shareprice stating: We continue to manage capital in a very disciplined, proactive manner, with an eye toward generating the greatest value for you, our shareholder. During the second quarter, we repurchased approximatelyl 50,000 shares at an average cost of S8.46 a share.
296.
Defendants eventually acknowledged the following in the
MD&A of its 3Q2006 Form 10-Q tiled with the SEC November 9, 2006 regarding its representations and warranties liability, in relevant part: Documentation. Repurchases related to documentation have increased in recent years. During the last three years, NetBank produced and sold a large volume of affordable housing program loans to FNMA. The underwriting and. documentation requirements under such programs are different than with traditional agency-eligible products in which the Company regularly deals and have resulted in a greater number of documentation deficiencies and consequently an increase in the volume ofrepurchases. ^4 Y>kY
Early payment default. As is customary in whole loan sales, NetBank -173-
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provides early payment default protection to the buyers. All offour sales from our non-conforming channel are whole loan sales. The increased production in this channel in recent years has given rise to an increase in repurchase volumes for early payment default. Likewise, commencing in 2004 and continuing in 2005 and 2006, our third party conforming channel sold larger percentages of loans in whole loan sales as opposed to agency mortgage backed securities, resulting in increases in repurchase volume related to early payment default because whole loan buyers are more likely to require sellers to repurchase loans in the case of early payment default. (Q3 2006 Form I 0-Q p. 27) (Emphasis added.)
297. Despite declining sales volumes the Company was incurring increasing repurchase volumes. The increase in the Company's repurchase obligation had a
material impact on its results of operations, and consequently, its financial position. The Company reported, although still insufficiently, related losses, in its Q3 2006 Form l0-Q, in relevant part: ...gain on sales of loans declined $23,118 during the three months ended September 30, 2006 as compared to the same period in 2005 primarily due to continued competitive pressures within the secondary market and higher repurchase volumes. (Q3 2006 Form l0-Q p. 29) (Dollars in thousands.)
298. Finally, in the Company 's earnings release for the fourth quarter of2006 dated February 21, 2007, Defendants acknowledged, in relevant part: As previously announced, repurchase requests in the non-conforming mortgage channel rose sharply following management's decision to -174-
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close the business and accelerated further at the end of the year. Provisions for the non-conforming channel were $30.3 fnillion, an increase of$25.7 million f-oni last quarter. Overall, provisions for the financial intermediary segment were 532.0 million versus $12.2 million the prior quarter. Management believes the worst of the non-conforming loan repurchase problem is now behind the company given the accelerated repurchase requests already received relative to the limited non-conforming production over the second half of 2006.
299.
As a result of Defendant' s failure to timely recognize known losses
regarding its representations and warranties liability, the Company's relevant
financial statements materially understated the Company's total liabilities and materially overstated net income (or understated net losses, as applicable). Therefore, the Company's relevant financial statements were materially false and misleading regarding the Company's results of operations and financial position, and thus, were not presented in conformity with GAAP. C.
Undisclosed Impairment of Goodwill
300. Additionally, as a result of the Defendant's failure to timely recognize known losses regarding its representations and warranties liability, Defendants caused the Company to issue the certain of the relevant financial statements which failed to timely recognize impairment losses regarding the Company's non-conforming loan operations and other non-traditional loan operations, specifically, regarding goodwill. -175-
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301.
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Goodwill, generally, is the premium paid in an acquisition above the
acquired entity's identifiable fair value and, if any, is reported as an asset by the acquiring entity. GAAP, specifically, FAS 142, Goodwill and Other Intangible Assets
("FAS 142"), requires goodwill to evaluated for impairment if an event occurs or circumstances change that would more likely than not reduce the fair value of a repor tin g unit (i.e. Heritage, the Compa ny 's non-conform ing loan operations, or
Beacon, the Company's other non-traditional loan operations) below its carrying
amount, but, at a minimum, annually. (FAS 142 1128) (Emphasis added.) FAS 142, further provides the guidance for recognizing and measuring goodwill impairment, if any. FAS 142 requires a two-step process whereby an entity first determines if the
carrying value of a reporting unit exceeds the fair value of such reporting unit, and, if so, then measures and recognizes the amount of impairment loss, if any, as the amount that the carrying value of reporting unit goodwill exceeds the implied fair
value of such goodwill. (FAS 142 ¶28). 302.
Had Defendants timely recognized known losses regarding its
representations and warranties liability, such losses would have been an indication that, more likely than not, the fair value of the Company's non-conforming loan
operations had been reduced below its carrying value, thereby requiring an evaluation -176-
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of goodwill impairment resulting in the timely recognition of impairment losses. Defendants disregarded its true losses regarding the Company's representations and warranties liability, and thereby disregarded significant indication of the impairment of goodwill related to its non-conforming loan operations, and avoided timely recognizing the impairment losses. 303.
Finally, as the indications of the impairment of goodwill related to its
non-conforming loan operations could not be further concealed, in the Company's
third quarter 2006 interim financial statements, the Defendants acknowledged, in relevant part: As a result of the Company's most recent impairment analyses, performed during the third quarter of 2006, management recorded a goodwill impairment of$19, 505 related to our nonconforming mnortgage operations. The impairment charge eliminated all of the goodwill related to our nonconforming operations and the Company received no tax benefit from this charge. (Q3 2006 Form 10-Q p. 16) (Emphasis added.)
304. As a result of Defendant ' s failure to timely recognize goodwill impairment losses regarding its non-conforming loan operations, the Company's relevant financial statements, exclusive of its third quarter 2006 interim financial statements, materially overstated the Company's total assets and materially overstated
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net income (or understated net losses, as applicable). Therefore, the Company's
relevant financial statements, exclusive of its third quarter 2006 interim Financial statements, were materially false and misleading regarding the Company's results of operations and financial position, and thus, were not presented in conformity with GAAP. 305.
Similarly, had Defendants timely recognized known losses regarding its
other non-traditional loan operations, such losses would have been an indication that, more likely than not, the fair value of such reporting unit (i.e., Beacon) had been reduced below its carrying value, thereby requiring an evaluation of goodwill impairment, resulting in the timely recognition of impairment losses. As discussed in greater detail elsewhere herein, the Company 's expansion away from its core business
and into the other non-traditional loan market , paired with lax underwriting guidelines, exposed the Company to a significant concentration of inherently high-
risk loans. Further, as discussed in greater detail elsewhere herein, Defendants were aware, or should have been aware, that concentration, in combination with certain prevailing market conditions, such as declining home values and increasing credit delinquencies and defaults, impaired the reporting unit's financial position and caused significant declines in the reporting unit's results of operations. Defendants -178-
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disregarded significant indications of the impairment of goodwill regarding its other non-traditional loan operations and avoided timely recognizing the impairment losses. 306.
As the indications of the impairment of goodwill regarding its other non-
traditional loan operations could not be further concealed, in the Company's Form 10-
Q for 2Q2006, filed with the SEC on August 8, 2006 , the Defendants admitted, in relevant part as follows: During the preparation and review of the these financial statements, management determined, based. on currently available market information as well as general trends in the industry, to record a goodwill impairment of $6,358 with respect to the second quarter of 2006 related to our 2004 acquisition of Beacon Credit Services. The impairment charge eliminated all ofthe goodwill related to the Beacon acquisition. (Q2 2006 Form 10-Q p. 17) (Emphasis added.) 307.
As a result of Defendant's failure to timely recognize goodwill
impairment losses regarding its other non-traditional loan operations goodwill, the Company's relevant financial statements, exclusive of its second and third quarter 2006 interim financial statements, materially overstated the Company's total assets
and materially overstated net income (or understated net losses, as applicable). Therefore, the Company's relevant financial statements, exclusive of its second and third quarter 2006 interim financial statements, were materially false and misleading regarding the Company's results of operations and financial position, and thus, were -179-
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not presented in conformity with GAAP. 308.
NetBank's difficulties arising from Beacon were, in part, the result of
NetBank's failure to conduct due diligence prior to the acquisition. According to a confidential witness, who was a senior executive of NetBank during the entire Class
Period, and who had regular daily interaction with. defendants Freeman, Herbert and Gross, it was defendant Freeman who made the decision for NetBank to purchase Beacon , the financier of watercraft and aircraft . After the decision was made, defendant Gross traveled to Connecticut to examine Beacon's books and records prior to the sale. However, Gross was not permitted by Beacon to adequately examine those books and records and a recommendation was made not to proceed with the purchase. According to a confidential witness , who was a senior executive of NetBank during
the entire Class Period, and who had regular daily interaction with defendants Freeman, Herbert and Gross, the principal of Beacon, at the time of the acquisition
by NetBank, was John Redmond who was a close personal friend of defendant Freeman. Nevertheless, defendant Freeman disregarded the fact that Beacon would not make its books and records available for inspection and the recommendation not to purchase the company and pushed through the approval of the purchase of Beacon
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Redmond, then a member of Beacon's senior management team , was poised to join NetBank to oversee the Beacon division. 309.
After acquiring it in .tune , 2004, Beacon caused NetBank to suffer a loss
of between approximately $200,000 and $300,000 every month, until the company was essentially given back to Defendant Freeman's personal friend, Redmond, at no cost in October 2006. The decisions o F the NetBank. Board of Directors were greatly influenced by William (Mickey) Ross as they pertained to Beacon who operated under the direction of Defendant Freeman. According to a confidential witness, who was a senior executive of NetBank during the entire Class Period, and who had
regular daily interaction with defendants Freeman, Herbert and Gross, at least with respect to the Beacon, Defendant Freeman effectively over-rode decisions of the NetBank Board of Directors' and instead imposed conduct that he knew was not in
the best interest of NetBank or its investors. As alleged herein, also according to a confidential witness who was a senior executive of NetBank during the entire Class Period and who had regular daily interaction with defendants Freeman, Herbert and Gross, the Beacon transaction and related exotic lending programs were one of the major contributing factors to NetBank's demise.
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A
Overstatement of Mortgage -Servicing Rights Assets
310.
Defendants caused the Company to issue the relevant financial
statements which failed to timely report known impairment losses regarding certain of the Company's mortgage-related assets, specifically, mortgage-servicing rights
("MSRs"). 311.
MSRs, generally, are the expected future servicing revenues in excess
of expected future servicing expenses related to the servicing of a pool ofrnortgages. GAAP, specifically, FAS 140, requires MSRs , subsequent to their initial recognition, to be reported at the lower of cost or fair value. FAS 140 provides, in relevant partA servicer that recognizes a servicing asset... shall account for the contract to service financial assets separately from those assets, as follows:
f.
Subsequently measure servicing assets by amortizing the amount recognize-d in proportion to and over the period of estimated net servicing income-the excess of servicing revenues over servicing costs...
g.
Subsequently evaluate and servicing assets as follows:
(1)
measure
impairment
of
Stratify servicing assets based on one or more of the predominant risk characteristics of the underlying financial assets. Those characteristics may include financial asset type, size, interest rate, date of -182-
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origination, term, and geographic location.
312.
(2)
Recognize impairment through a valuation allowance for an individual stratum . The amount of impairment recognized shall be the ainount hy which c)a the carrying amount of servicing assets Jr stratum exceeds their fair value. The fair value of servicing assets that have not been recognized shall not be used in the evaluation of impairment.
(3)
Adjust the valuation allowance to reflect changes in the measurement ofimpairment subsequent to the initial measurement of impairment. Fair value in excess ofthe carrying amount of'servicing assets for that stratum, however, shall not he recognized. This Statement does not address when an entity should record a direct write-down of recognized servicing assets... (FAS 140 1[63) (Emphasis added.) (Footnote omitted.)
Changes in the fair value of MSRs are caused by changes in the
underlying pool of mortgages. The Company indicated the following, in relevant part, regarding the value of its MSRs: An increase in delinquencies and defaults of mortgage loans will also adversely impact our loan servicing operations. Under certain types of servicing contracts, particularly contracts to service pooled or securitized loans, we must advance all or part ofthe scheduled payments to the owner of the loan, even when loan payments are delinquent. Also, to protect their lien on mortgaged property, owners of mortgage loans usually require us to advance mortgage and hazard insurance and tax
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payments on schedule even if sufficient escrow funds are unavailable.
A services is generally reimbursed for such advances by the mortgage loan owner or from liquidation proceeds. However, prior to the liquidation ofa loan, we Inust generally bear the cost offunds advanced and the increased costs oJ' attempting to collect on delinquent and defaulted mortgage loans. In addition, we must generally forego servicing income from the time such loan becomes delinquent until it is ,foreclosed upon or brought cur•r°ent. (2005 Form 10-K p. 38)
313.
According to the Company's disclosures, its MSRs primarily related to
agency-eligible loans. Defendants described agency-eligible loans as follows: Agency-eligible mortgage loans are those mortgage loans that meet the size, documentation, borrower and credit standards to qualify to be pooled into mortgage-backed securities guaranteed by government sponsored enterprises, such as Fannie Mae, Freddie Mae and Ginnie Mae. (2005 Form 10-K p. 13) 314.
Thus, although agency-eligible loans would have typically excluded non-
conforming loans, based on the Company's definition and lack of any statements to the contrary, it is reasonable to conclude such agency eligible loans included the
Company's other non-traditional loans, which was not the Company's core business, and included those other non-traditional loans originated by the Company subject to the Company's lax underwriting guidelines. Such factors, known to the Defendants, and in combination with certain prevailing market conditions, such as declining home -184-
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values and increasing credit delinquencies and defaults, as discussed in greater detail elsewhere herein, caused significant declines in the fair value of its MSRs. Defendants disregarded the significant indications ofthe impairment ofits MSRs and avoided timely recognizing the related known impairment losses. 315.
Finally, as the Company was forced to sell-off a significant portion its
MSRs, the impairment of its MSRs could not be further concealed, Defendants
acknowledged, although still insufficiently, for the three months ended September 30, 2006, losses on sales ofM5Rs of$29.8 million, in addition to iVISR impairment losses f r the three and nine months ended Septenmber 30, 2006 of, respectively, $ 1.5 million
and $7.4 million. (Q3 2006 Form I0-Q p. 4) Not until the second quarter of 2007 did Defendants acknowledge, on the Company's Form 8-K filed with the SEC June 21, 2007, additional expected losses of $7.5 million on the sale of the Company's remaining MSRs. 316.
As a result of Defendant 's failure to timely recognize known losses
regarding the impairment of its MSRs, the Company's relevant financial statements
materially overstated the Company's total assets and materially overstated net income (or understated net losses, as applicable). Therefore, the Company's relevant financial statements were materially false and misleading regarding the Company's results of -185-
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operations and financial position, and thus, were not presented in conformity with
GAAP. E.
Ineffective Disclosure Controls and Procedures and Internal Control. over Financial Reporting
317.
The SEC defines "disclosure controls and procedures" as:
...controls and other procedures of an issuer that are designed to ensure that inform ation required to he disclosed by the issuer in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported, with the time periods specified in the Commission 's rules and forms.... (SEC Final Rule Release Nos. 338124, 34-46427, IC-25722; File No. S7 -21-02) (emphasis added and footnotes omitted).
318. Internal control over financial reporting is defined in Public Company Accounting Oversight Board ("PCAOB") Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting.Perfbrmed in Conjunction with An Audit
of Financial Statements ("AS 2"), as follows, in relevant part: A process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation qffinancial statementsfor external purposes in accordance with, generally accepted accounting principles and includes those policies and procedures that:
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(1)
Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(2)
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
(3)
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Notably, the above definition is the same one used by the SEC in its rules requiring management to report on internal control over financial reporting, except the word
"registrant " has been changed to "company" to conform to the wording in this standard . (See Exchange Act Rules 13a-15(1) and 15d - 15(t).2/) (AS 2 ¶¶7). 319.
Exchange Act Rules 13a- 14 and 15d-14 require the Company's principal
executive officer and principal financial officer, or equivalents, to quarterly and
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date within 90 days prior to the filing date of the report. Further, the Company is required to annually report on the effectiveness of its internal control over financial. reporting. Auditing Standard No. 2 states, in relevant part: A company subject to the reporting requirements of the Securities Exchange Act of 1934 (an "issuer") is required to include in its annual report a report of management on the company's internal control over financial reporting... The report of management is required to contain management's assessment of the effectiveness of the company's internal control over financial reporting as of the end of the company's most recent fiscal year, including a statement as to whether the company's internal control over financial reporting is effective... (AS 2 ¶2). 320.
During the Class Period, Defendants caused the Company to issue
materially false and misleading statements regarding the effectiveness of the Company's disclosure controls and procedures, and internal control over financial
reporting. With the exception of December 31, 2004, Defendants disclosed the Company's disclosure controls and procedures were effective as of the date of each individual Exchange Act report that was filed during the Class Period. (Q1 2005
Form 10-Q p. 28, Q2 2005 Form 10-Q p. 3 6, Q3 2005 Form 10-Q p. 37, 2005 Form 1.0-K p. 124, Q 1 2006 Form 10-Q p. 34, Q2 2006 Form 10-Q p. 41, Q3 2006 Form 10-Q p. 39) Further, Defendants disclosed that internal control over financial reporting as of December 31, 2005. (2005 Form 10-K p. 125).
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32 1. Defendants caused the Company to issue the relevant financial statements that were materially misstated with respect to the Company's
representations and warranties liability, goodwill, and MSRs and avoided timely recognizing losses. Defendants caused the Company to issue the relevant financial
statements which were materially false and misleading regarding the Company's results of operations and financial position, and thus, were not presented in conformity with GAAP. Thereby, the Company's disclosure controls and procedures, and internal control over financial reporting, were not effective as of the date of each individual Exchange Act report that was filed during the Class Period.
XlI. ADDITIONAL SCIENTER ALLEGATIONS 322.
As alleged herein, Defendants acted with scienter in that Defendants
knew that the public documents and statements issued or disseminated in the name of the Company were materially false and misleading; knew that such statements or documents would be issued or disseminated to the investing public; and knowingly and substantially participated, approved or acquiesced in the issuance or dissemination of such statements or documents as primary violations of the federal securities laws. As set forth elsewhere herein in detail, Defendants, by virtue of their receipt of information reflecting the true facts regarding NetBank, their control over, -189-
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receipt of and/or modification of NetBank's allegedly materially misleading misstatements and/or their associations with the Company which made them privy to confidential proprietary information concerning NetBank, participated in the fraudulent scheme alleged herein.. 323. Among other things, Defendants' scienter is specifically demonstrated by their intentional and purposeful withholding of information from the investing public as to the SEC's communications and investigations into the Company's material misapplication of GAAP and FAS 133 in connection with its financial
reporting with the SEC. Such misapplications materially misstated the Company's financial statements as to the results and condition of the Company since at least March 16, 2005. Defendants admit they were notified by the SEC of such accounting misstatements as early as August 31, 2006, but purposely withheld that information from the investing public for nearly a year, and finally disclosed such information on August 10, 2007, when NetBank was in its final throes of its ultimate collapse.
Defendants' withholding of this information was designed to conceal and continue their fraudulent scheme as alleged. 324.
Similarly, Defendants failed to disclose that the resignation of NetBank's
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internal control failings, including its misapplication of FAS 133. Indeed , nearly a year after E&Y resigned, the Company revealed that E&Y had actually withdrawn its prior audit opinions for NetBank's 2004 and 2005 Form 10-K. E&Y was also then
refusing to allow for NetBank to File its 2006 FormI0-K as a further result. 325.
Defendants' scienter is further demonstrated by their intentional and
purposeful failure to file any financial reports with the SEC following the filing ofthe Form l0--Q for the fiscal quarter ended September 31, 2006..As such, Defendants not only failed to report timely and accurately NetBank's financial results and condition after 3Q2006, but Defendants failed to correct and restate the Company prior financial statements, and instead simply waited for the Company to declare bankruptcy and dissolve. Defendants' actions and inactions in this regard amounted to a concerted effort to conceal their fraud as alleged herein. XIII. LOSS CAUSATION/ECONOMIC LOSS 326. During the Class Period, as alleged. herein, the Defendants engaged in a scheme to deceive the market and artificially inflate the price of NetBank's securities . In doing so, Defendants made material misrepresentations and omissions
regarding, among other things, the Company's financial reporting, financial
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condition, internal controls, business operations, corporate restructuring, core banking business, lending practices and exposure to subprime mortgages. When the
truth concerning these issues was revealed to the investing public beginning on May 21, 2007, the price of NetBank ' s securities materially declined as the remaining artificial inflation dissipated. As a result of their purchases of NetBank securities during the Class Period at artificially inflated prices and subsequent disclosures
which removed the inflation from such securities, Plaintiff and other members ofthe Class suffered economic loss, i.e., damages under the federal securities laws. 327. The markets for NetBank' s securities were open, well-developed and efficient at all relevant times. As a result of these materially false and misleading statements and failures to disclose, NetBank's securities traded at artificially inflated
prices during the Class Period. Plaintiff and other members of the Class purchased or otherwise acquired NetBank securities relying upon the integrity of the market price of NetBank's securities and market information relating to NetBank, and have been
damaged thereby. 328. During the Class Period, Defendants materially misled the investing public, thereby inflating the prices of NetBank's securities , by publicly issuing false and misleading statements and omitting to disclose material facts necessary to make -192-
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Defendants' statements, as set forth herein, not false and misleading. Said statements and omissions were materially false and misleading in that they fail to disclose
material adverse information and misrepresented the truth about the Company, its business and operations, as alleged herein. 329. At all relevant times, the material misrepresentations and omissions particularized in this Amended Complaint directly or proximately caused, or were a
substantial contributing cause of, the damages sustained by Plaintiff and other members of the Class. As described herein, during the Class Period, Defendants made or caused to be made a series of materially false or misleading statements about NetBank's business, prospects, operations and results. These material misstatements
and omissions had the cause and effect of creating in the market an unrealistically positive assessment of NetBank and its business , prospects, operations and results, thus causing the Company's securities to be overvalued and artificially inflated at all relevant times. 330. When the full impact of Defendants' prior misrepresentations and fraudulent conduct were disclosed and became apparent to the market, the prices of NetBank' s securities fell precipitously as the remaining artificial inflation came out. As a result of their purchases of NetBank' s securities during the Class Period, -193-
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Plaintiff and the other Class members suffered economic loss, i.e., damages under the federal securities laws, 331. By failing to disclose the truth about its core businesses, lending policies and practices and accounting practices, Defendants presented a misleading picture of NetBank's operations and financial performance. Thus, instead of disclosing during the Class Period the truth about NetBank's business, prospects, operations and
results, Defendants caused NetBank to conceal the truth. 332.
Defendants' false and misleading statements had the intended effect and
caused NetBank's common stock to trade at artificially inflated levels throughout the
Class Period, reaching as high as $8.74 per share on May 16, 2005, the start of the Class Period. 333. Beginning at least as early as October 2006, adverse facts and circumstances attributable to the fraud alleged herein were learned by the investing public, and as a result, the price of NetBank stock suffered numerous declines. This adverse information included the "resignation ", or firing of NetBank CEO Freeman, the resignation of NetBank's auditor E&Y, reports of dismal financial results,
reported delays in reporting financial data and filing requisite reports with the SEC,
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and the Company's failure to file requisite financial reports with the SEC. "While these adverse disclosures revealed business reversals caused by defendants' fraud, and precipitated stock price declines which were the consequence of Defendants' fraud (and its gradual unraveling), the major elements ofthe fraudulent scheme itself were not revealed until the Company's shocking disclosures on May 21, 2007, and
thereafter. 334.
As a direct result of Defendant s' disclosures on May 21, 2007,
NetBank's common stock price fell precipitously. These drops removed the remaining
inflation from the price of NetBank's securities, causing real economic loss to investors who had purchased the Company's securities during the Class Period. 335. The approximate 92% decline in the price of NetBank's common stock after these disclosures came to light was a direct result of the nature and extent of Defendants ' fraud finally being revealed to investors and the market. The timing and magnitude of NetBank's common stock price declines negate any inference that the loss suffered by Plaintiff and the other Class members was caused by changed market conditions, macroeconomic or industry factors or Company-specific facts unrelated to the Defendants' fraudulent conduct. The economic loss, i.e., damages, suffered by Plaintiff and the other Class members was a direct result of Defendants' fraudulent -195-
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scheme to artificially inflate the prices of NetBank's securities and the subsequent
significant decline in the value of NetBank's securities when Defendants' prior misrepresentations and other fraudulent conduct were revealed. 336. The price declines directly and proximately resulting from the above discussed disclosures were not caused by industry news, randomness or by NetBank
related information unrelated to the alleged fraud. Each of the above referenced disclosures partially corrected the false and misleading information previously available to the market by the Defendants' wrongful course of conduct. Plaintiff and the Class seek by this Amended Complaint to be compensated for those resulting economic losses. XIV. FRAUD ON THE MARKET DOCTRINE 3 37.
Throughout the Class Period the market for NetBank common stock was
an efficient market for the following reasons, among others: a.
NetBank common stock met the requirements ror listing, and was
listed and actively traded on the NASDAQ; b.
As a regulated issuer of securities, NetBank filed periodic public
reports with the SEC and the NASDAQ;
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c.
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The common stock of NetBank was followed by securities
analysts who wrote research reports that were distributed to brokerage sales personnel
and to customers of investment firms. These research reports were publicly available and entered the public marketplace; and d.
Plaintiff and the other members of the proposed Class purchased
NetBank common stock and other securities during the time Defendants are alleged to have engaged in the fraudulent acts and practices alleged herein, and did not know
the truth. 338. The -market for NetBank common stock promptly digested current information with respect to NetBank common stock from all publicly available sources, and all such information was reflected in the market prices of said securities. Under these circumstances, all those who purchased NetBank common stock during the Class Period suffered similar injury through their acquisition of such securities at artificially inflated prices. Hence, the fraud-on-the-market doctrine of reliance applies to the claims alleged herein. 339. At all relevant times, the market for NetBank's securities was an efficient market for the following reasons, among others:
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(a) NetBank's stock met the requirements for listing, and was listed and actively traded on the National Association of Securities Dealers Automated
Quotation System ("NASDAQ"), a highly efficient and automated market; (b) as a regulated issuer, NetBank filed periodic public reports with the SEC and the NASDAQ; (c) NetBank regularly communicated with public investors via established
market communication mechanisms, including through conference calls with investors and the issuance 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) NetBank was.followed by several securities analysts employed by major
brokerage firms who wrote reports which were distributed to the sales force and certain customers of their respective brokerage firms. Each of these reports was publicly available and entered the public marketplace. 340.
As a result of the foregoing, the markets for NetBank's securities
promptly digested current information regarding NetBank from all publicly available sources and reflected such information in the price of the Company's securities.
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Under these circumstances , all purchasers of NetBank 's securities during the Class Period suffered similar injury through their purchase of the publicly traded securities of NetBank at artificially inflated prices, and a presumption of reliance applies. XV.
INAPPLICABILITY OF SAFE HARBOR 341. The statutory safe harbor provided for forward-looking statements
("FLS") does not apply to any false FLS that may be pleaded herein. The statutory safe harbor for FLS does not apply because the safe harbor exempts from coverage
the Company's false financial statements. Moreover, any such FLS pleaded herein were not specifically identified. as "forward-looking statements" when made and/or were not accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the FLS. To the extent that the statutory safe harbor may apply to any of these false statements
alleged herein, the Defendants are liable for those false forward-looking statements because at the time each of those statements was made the speaker actually knew the
statement was false and the statement was authorized and/or approved by an executive officer of NetBank who actually knew that those statements were false when made.
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CLAIMS FOR RELIEF COUNT I Violation of Section 10(b) of the Exchang e Act and Rule lOb-5 Promulgated Thereunder Against All Defendants
342.
Plaintiff repeats and realleges each and every allegation contained above
as if fully set forth herein. 343. During the Class Period, Defendants carried out a plan, scheme and course of conduct which was intended to and, throughout the Class Period, did: (i) deceive the investing public regarding NetBank's business, operations, management
and the intrinsic value of NetBank securities; and (ii) cause Plaintiff and other members of the Class to purchase NetBank's securities at artificially inflated prices. In furtherance of this unlawful scheme, plan and course of conduct, Defendants, and each of them, took the actions set forth herein. 344. 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 make the statements not misleading; and (c) engaged in acts, practices, and a course of business which operated as a fraud and deceit upon the purchasers of
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the Company's securities in an effort to maintain artificially high market prices for NetBank's securities in violation of Section 10(h) of the Exchange Act and Rule I Ob5 promulgated thereunder. All Defendants are sued either as primary participants in
the wrongful and illegal conduct charged herein or as controlling persons as alleged below. 345.
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, operations and future prospects of NetBank as specified herein. 346, These Defendants employed devices, schemes and artifices to defraud, while in possession of material adverse non-public i.nf'ormation and engaged in acts, practices, and a course of conduct as alleged herein in an effort to assure investors of
NetBank'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 NetBank and its business operations and future prospects in the light of the circumstances under which they were made, not misleading, as set forth more -201-
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particularly herein, and engaged in transactions, practices and a course of business which operated as a fraud and deceit upon the purchasers of NetBank's securities
during the Class Period. 347. Each of the Individual Defendants' piiimary liability, and controlling person liability, arises from the following facts: (i) the Individual Defendants were high-level executives and/or directors at the Company during the Class Period and members of the Company' s management team or had control thereof, (ii) each of these Defendants , by virtue of his responsibilities and activities as a senior officer and/or director of the Company was privy to and participated in the creation,
development and reporting of the Company's internal budgets, plans, projections and/or reports; (iii) each of these Defendants enjoyed significant personal contact and
familiarity with the other Defendants and was advised of and had access to other members of the Company's management team, internal reports and other data and information about the Company's finances, operations, and sales at all relevant times ; and (iv) each of these Defendants was aware of the Company"s dissemination of
information to the investing public which they knew or recklessly disregarded was materially false and misleading. 348. The Defendants had actual knowledge of the misrepresentations and -202-
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omissions of material facts set forth herein, or acted with reckless disregard for the truth, in that they failed to ascertain and to disclose such facts, even though such facts were available to them. Such Defendants ' material misrepresentations and/or omissions were done knowingly or recklessly and for the purpose and effect of concealing NetBank's operating condition and future business prospects from the investing public and supporting the artificially inflated price of its securities . As
demonstrated by Defendants ' overstatements and misstatements of the Company's business, operations and earnings throughout the Class Period, Defendants, ifthey did not have actual knowledge of the misrepresentations and omissions alleged, were sufficiently reckless in failing to obtain such knowledge by deliberately refraining from taking those steps necessary to discover whether those statements were false or misleading. 349. As a result of the dissemination of the materially false and misleading information and failure to disclose material facts, as set forth above, the market prices ofNetBank' s securities were artificially inflated during the Class Period. In ignorance of the fact that market prices ofNetBank's pu blicly-traded securities were artificially inflated, and relying directly or indirectly on the false and misleading statements made by Defendants, or upon the integrity of the market in which the securities trade, -203-
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and/or on the absence of material adverse information that was known to or recklessly disregarded by Defendants but not disclosed in public statements by Defendants during the Class Period, Plaintiff and the other members of the Class acquired NetBank securities during the Class Period at artificially high prices and were
damaged thereby. 350. At the time of said misrepresentations and omissions, Plaintiff and other members of the Class were ignorant of their falsity, and believed them to be true. Had Plaintiff and the other members of the Class and the marketplace known the truth regarding NetBank's Financial results, which were not disclosed by Defendants,
Plaintiff and other members of the Class would not have purchased or otherwise acquired their NetBank securities, or, if they had acquired such securities during the Class Period, they would not have done so at the artificially inflated prices which they paid. 351. By virtue of the foregoing, Defendants have violated Section 10(b) of the Exchange Act, and Rule I Ob-5 promulgated thereunder. 352. As a direct and proximate result of Defendants ' wrongful conduct, Plaintiff and the other members of the Class suffered damages in connection with
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their respective purchases and sales of the Company's securities during the Class
Period. COUNT 1[
Violation of Section 20(a) Of The Exchange.A.et Against the Individual Defendants
353.
Plaintiff repeats and realleges each and every allegation contained above
as if fully set forth herein. 354. The Individual Defendants acted as controlling persons of NetBank within the meaning of Section 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 financial statements filed by the Company with the SFC and disseminated to the investing public, the Individual Defendants 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 which Plaintiff contends are false and misleading. The Individual Defendants were provided with or had. unlimited access to copies of the Company's reports, press releases,
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public filings and other statements alleged by Plaintiff 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. 355. In particular, each of these Defendants had direct and supervisory involvement in the day-to-day operations of the Company and, therefore, is presumed to have had the power to control or influence the particular transactions giving rise
to the securities violations as alleged herein, and exercised the same. 356.
As set forth above, NetBank and the Individual Defendants each violated
Section 10(b) and Rule lOb-5 by their acts and omissions as alleged in this Complaint. By virtue of their positions as controlling persons, the Individual Defendants are liable pursuant to Section 20(a) of the Exchange Act. As a direct and
proximate result ofDefendants' wrongful conduct, Plaintiff and other members of the Class suffered damages in connection with their purchases of the Company's securities during the Class Period. PRAYER FOR RELIEF WHEREFORE , Plaintiff, on his own behalf and on behalf of the other members of the Class, demands judgment against the Defendants as follows:
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A.
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Determining that this action is properly maintainable as a class action
pursuant to Rule 23 of the Federal Rules of Civil Procedure; B.
Certifying Plaintiff as the representative of the Class and his counsel as
counsel for the Class; C.
Declaring that Defendants violated the federal securities laws by reason
of the wrongful conduct alleged herein; D.
Awarding monetary damages against all Defendants, jointly and
severally, in favor of Plaintiff and the other members of the Class for all losses and damages suffered as a result of the acts and transactions complained of herein, together with prejudgment interest from the date of the wrongs to the date of the
judgment herein; E.
Awarding Plaintiff the costs, expenses, and disbursements incurred in
this action, including reasonable attorneys' and experts' fees; and F.
Awarding Plaintiff and the other members of the Class such other and
further relief as the Court may deem just and proper in light of all the circumstances of this case.
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JURY TRIAL DEMAND Plaintiff demands a trial by jury of all claims and issues so triable in this action. Dated: July 3 , 2008
Respectfully submitted,
/s/ Michael J. Gorby! _ Michael J. Gorby, Esq.
Merrill G. Davidoff, Esq.
Mary Donne Peters, Esq.
Michael Dell'Angelo, Esq.
GORBV, PETERS &
Lane L. Vines, Esq.
/s/ Merrill G. Davidoff
ASSOCIATES, P.C.
BERGER & MONTAGUE, P.C.
Two Ravinia Drive, Suite 150()
1622 Locust Street
Atlanta, GA 30346-2104
Philadelphia, PA 19103
Telephone: (404) 239-1150
Telephone: (215) 875-3000
Fax: (404) 239-.1179
Fax: (215) 875-4604
mgorby@gorbyree-\,-,es.com
m davi do ffir^,bn1. net
mpeters [c gorbyreeves.com
[email protected] [email protected]
Local Counsel for Lead Plaintiff
Lead Counsel for Lead Plaintiff
Robert A. Brown and the Proposed Class
Robert A. Brown and the Proposed Class
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ATTACHMENT
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IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF GEORGIA ATLANTA DIVISION
JOHNNY R. ADCOCK, on Behalf of Himself and All Others Similarly Situated,
Plaintiff, C.A. No. 1:07-CV-2298-BBM V.
JURY TRIAL DEMANDED
NETBANK, INC., STEVEN F. HERBERT and DOUGLAS K. FREEMAN, Defendants. x
ARASH VAHDAT, on Behalf of Himself and All Others Similarly Situated,
Plaintiff, C.A. No. l:07-CV-2631-BBM V.
JURY TRIAL DEMANDED NETBANK, INC., STEVEN F. HERBERT and DOUGLAS K. FREEMAN,
Defendants.
CERTIFICATION OF ROBERT A. BROWN PURSUANT TO THE PRIVATE SECURITIES REFORM ACT OF 1995 "PSLRA" Robert A. Brown ("Plaintiff '), duly swears and says, as to the claims asserted under the federal securities laws, that:
1.
1 have reviewed the complaints filed in the litigations captioned
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Adcock v. NetBank, Inc., et al., No. 07-cv-02298-BBM (N.D. Ga.) and Vahdat v. NetBank, Inc., et al., No. 07-cv-02631-BBM (N.D. Ga.), which alleged violations
of the federal securities laws against NetBank, Inc. ("NetBank" or the "Company") and several of its officers and directors , including Steven F. Herbert and Douglas K. Freeman. I have also reviewed a draft complaint that may be filed on my behalf against NetBank, Inc. and related persons. I approve of its contents, and I authorize its filing. I authorize Berger & Montague, P.C. to represent me in this action.
2.
1 did not purchase the security that is the subject of this action at the
direction of my counsel or in order to participate in this private action. 3.
I am willing to serve as a representative plaintiff on behalf of the
class, including providing testimony at deposition and trial, if necessary. 4.
My transactions in the common stock of NetBank the relevant class
period March 16, 2005 through and including May 21, 2007 are as follows: SHARES PURCHASED
DATE OF PURCHASE
PRICE PER SHARE
DATE OF SALE
PRICE PER SHARE
See attached schedule SHARES SOLD
See attached schedule 2
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5.
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1 state that I own and/or control, on behalf of myself and members of
my immediate family, the several investment accounts, listed on the attached schedule: Robert A. Brown IRA; Robert A. Brown & Judith E. Thomson JTWROS; Robert A. Brown, Custodian FBO Jared T. Brown; Robert A. Brown,
Custodian FBO Maia T. Brown; and Judith E. Thomson IRA. Ms. Judith Thomson is my wife. Jared T. Brown and Maia T. Brown are my minor children. At all
times relevant, I had and exercised complete investment control and authority for all investment transactions in all of the above accounts. 6.
In the three years (3) prior to the date of this certification, I have
served as the court-appointed lead plaintiff and class representative in one other action filed under the United States federal securities laws; that litigation is captioned Brown v. Kinross Gold U.S.A., Inc., No. CV-S-02-0605-KJD -(RJJ) (D. Nev.). Specifically, I was appointed by the court in that litigation to serve as one of the several lead plaintiffs by Order entered August 8, 2002 and as one of the
several class representatives by Order entered June 14, 2005. Other than the above Kinross litigation, I have not previously sought to serve as a representative party in
an action filed under the United States federal securities laws. 7.
1 have not and will not accept any payment for serving as a
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ROBERT A. BROWN NETBANK, INC. COMMON STOCK TRANSACTIONAL SUMMARY Type of transaction
Date
Shares traded
Price uer Share
Total dollar value of frarsaction
Total Losses
Robert A. Brown IRA Buy Buy Buy Buy Buy Buy Buy
09-May-2006 18-May-2006 23-May-2006 06-Jun-2006 13-Jun-2006 15-Jun-2006 20-Jun-2006
Buy Buy
02-Feb-2007
45.7778 51.3333 49.6774 50.5728 49.6774 0.3207 50.1751 114,450.0000
$6.750 $6.000 $6,200 $6.110 $6.200 $6.049 $6.139 $3.715
-$309.00 -$309.00 -$309.00 -$309.00 -$309.00 -$1.94 -$309.00 -$425,178.70
05-Feb-2007 07-Feb-2007
157,000.0000 141,318.0000
$3.705 $3.665
-$581,681.95
Buy Buy
28-Feb-2007
458,0000
$3,200
-$1,473.60
Buy Buy Buy Buy
06-Mar-2007 13-Mar-2007 14-Mar-2007 27-Mar-2007
998.1618 100.0000 163,446.0000 98,522.0000
$2.724 $2.490 $2.490 $2.395
-$2,719.00 -$257.00 -$406,988.54 -$235,961.14
Totals
sell
-2,174,043.2900
676,589.6963 24-May-2007 24-May-2007 24-May-2007
Sell Sell
-$517,927.42
Totals
512,585.6963 12,800.0000 151,204.0000
$195,075.18 $4,931.71 $58,208.88
$0.390 $0.390 $0,390
676,589.6963
$
258,215.77 $
Net Loss
Robert A . Brown & Judith E. Thomson Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy
11-Oct-2005 18-Oct-2005 25-Oct-2005 01-Nov-2005 08-Nov-2005 15-Nov-2005 15-Nov-2005
26.7606 27.1429 26.4968 26.4892 27.4151 14.0677
22-Nov-2005
06-Dec-2005 13-Dec-2005 15-Dec-2005 15-Dec-2005 20-17ec-2005 27-Dec-2005 03-Jan-2006 10-Jan-2006 17-Jan-2006 24-Jan-2006
29.4014
$7.810 $7.700 $7.888 $7.890 $7.660 37.110 $7.110
-$209.00 -$209.00 -$209.00 -$209.00 -$210.00 -$100.00 -$210.00
28.6694
$7.290
-$210.00
28.9041 42.3024 0,3087
$7.300 $7.210 57.839
0.1454 42,0110 41.5531 42.7374 40.7210 41.1611 42.3024
$7.840 $7.260 $7.340 $7.160 $7.490 $7,410 $7.210
-$211.00 -$306,00 -$2.42 -$1.14 -$306.00 -$306.00 -$306.00 $306.00 -$306.00 $306.00
-1,915 ,827.52
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Typ e of t ransaction
Date
Buy Buy Buy Buy Buy Buy Buy
07-Feb-2006 14-Feb-2006 21-Feb-2006 26-Feb-2006 07-Mar-2006 14-Mar-2006 15-Mar-2006
Buy
21-Mar-2006
Buy
28-Mar-2006
Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy
04-Apr-2006 11-Apr-2006 18-Apr-2006 25-Apr-2006 02-May-2006 15-Jun-2006 21-Feb-2007 22-Feb-2047 27-Feb-2007 28-Feb-2007 13-Mar-2007 13-Mar-2007 14-Mar-2007
42.7778 42.8173 42,2289 44.3642 44.6377 3.5719 500.0000 2,108.0000 2,644.0000 2,817.0000 3,764.1801 100.0000 1,800.0000
Buy
14-Mar-2007
5,944.0000
Buy Buy Buy Buy
14-Mar-2007 20-Mar-2007 22-Mar-2007 22-Mar-2007
Buy
Buy Buy
Shares traded
Filed 07/03/2008
Price per Share
Page 69 of 74
Tota l dollar value of transaction
$7.480 $7.450 $7.396 $7.320 $7.240 $7.310 $7.310
-$307.00 -$307.00 -$307.00 -$308.00 -$308.00 -$308.00 -$12.21
40.7324
$7.537
-$308.00
42.7577
$7.180
-$308.00
$7.200 $7.170 $7170 $6.920 $6.900 $6.050 $3.520 $3.600 $3.460 $3.250 $2.656 $2.490 $2,480
-$308.00 -$308.00 -$308.00 -$308.00 -$308.00 -$21.61 $1,765.95 47,410.57 -$9,188.85 -$9,198.46 -$10,000.00 -$257.00 -$4,464.00
25,500.0000 4,462.5000 18,173.0000 418.0000
$2,485 $2,490 $2,240 $2.170 $2.350
-$63,495.00 410,000.04 -$39,708.96 -$996.25
23-Mar-2007
7,398.0000
$2.340
417,423.24
23-Mar-2007 26-Mar-2007
3,400.0000 21,617.0000
$2.410 $2.390
-$8,245.95 -$51,660.58
Buy
27-Mar-2007
28,612.0000
$2,390
-$68,812.81
Buy
24-Apr-2007
3,249.2537
$2.010
46,535.00
Totals Sell Sell
41.0428 41.0738 41,3737 41.9399 42.5414 41.9973 1.6703
Totals
100,247.0506 33,344.0000
-$14,778.84
$331,920.84
133591.0506 22-May-2007 24-May-2007
Total Losses
$0.373 $0.390
$36,469.96 $12,834.01 $49,303.97
133,591.0506
Not Loss
$
-295,450.88
$
-4.543.66
Robert A. Brown. Custodian FBO Jared T. Brown Buy Buy
06-Mar-2007 27-Mat-2007 Totals
Sell
$2.720 $2.400
2,445.8333
$429.00 -$5,499.00 -$5,928.00
2,445.8333 22-May-2007
Net Loss
156.2500 2,289.5833
$0.566
$1,384.34
Case 1:07-cv-02298 -BBM
Type of transaction
ate
Document 35-3
Shares traded
Filed 07/03/2008
Page 70 of 74
Price per Share
Total dollar value of transaction
Total Losses
Robert A . Brown, Custodian FBO Maia 7 Brown Buy
10-Apr-2007
3,013.4805
$1,780
-$5,367.00
Sell
22-May-2007
3,013.4805
$0.568
$1,705.63
Net Loss
$
Judith E. Thomson IRA Buy Buy
27-Jun-2006 05-Jul-2006 11-Jul-2006 18-Jul-2006
Buy Buy Buy Buy
25-Jul-2006 01-Aug-2006 08-Aug-2006
Buy Buy
57.1205 58.2137 55.9140
$6.390 $6.271) $6.510
-$365.00 -$365.00 -$365.00
58.6161 57.8862
$8.210 36.310 35.260 $4.200
-$365.00 -$365.00 -$365.00 -$365.00
35.498 $5.380
-$365.00
69.3916 86.6667 66.2059 67.6580 62.3942
Buy
15-Aug-2006 22-Aug-2006 05-Sep-2006 12-Sep-2006 19-Sep-2006
Buy
Buy Buy Buy Buy Buy
Buy Buy Buy
Buy Buy Buy
59.8684 61.3828
35.850 $6.080 35.930
-$365.00 -$365.00 -$365.00 -$365.00
26-Sep-2006
60.06660
36.060
-$365.00
03-Oct-2006 10-Oct-2006 17-Oct-2006
60,6312 58.2400 60.6667
$6.020 36.250
24-Oct-2006 07-Nov-2006 14-Nov-2006
63.2054 66.7276
$6.000 $5.759 $5.470
-$365.00 -$365.00 -$365.00
68.6792
$5.300
-$365.00
21-Nov-2006
69.5985 75.5579 78.3262
$5230 $4.818 $4.660
-$365.00
12-Dec-2006 19-Deo-2006 26-11^-2006 03-Jan-2007 09-Jan-2007 16-Jan-2007 23-Jan-2007
77.4468 86.5225 79.6499 842956 89.8765
$4.700 $4.207 $4.570 $4.330 $4.050
4365.00
88.9976 94.5595
$4.090 $3.860
06-Feb-2007 08-Feb-2007 14-Feb-2007 28-Feb-2007
97.6000 14,200.0000 73,472.0000 520.0000 429.0441 72,685.0000 11,692.0000 6,033.0000 78,651.0000
$3.750 $3.580 $3.580 $3.200 $2,720 $2.480 $2.480 $2.380 $2.380
-$365.00 -$366.00 -$366.00 -$51,045.95 -$264,128.79 -$1,672.00 -$1,171.00 -$180,266.80 -$29,004.16 -$14,449.99 -$188,370.10
28-Nov-2006 05-Dec-2006
Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy Buy
06-Mar-2007 14-Mar-2007 16-Mar-2007 27-Mar-2007 28-Mar-2007
Buy Buy Buy Buy Totals
259,8Q3.8094
-$365.00 -$365.00
-$365.00 -$365.00 -$365.00 -$365.00 -$385.00 -$365.00
-$741,060.79
-3,661.37
Case 1:07-cv-02298- BBM
Type of transaction
Date
Sell Sell
24-May-2007 24-May-2007 Totals
Document 35-3
Shares traded
174,9M.8094 84,897.0000 259,803.8094
Net Loss TOTAL SHARES TOTAL NET LOSS
Filed 07/03/2008
Price per Share
$0.390 $0.390
Page 71 of 74
Total dollar value of transaction
Total Losses
$66,507.28 $32,680.90 $99,188.18 $
-674,553.51
$
-2,894,036.94
1,075,443.8701
Case 1 : 07-cv-02298 -BBM
Document 35-3
Filed 07/03/2008
Page 72 of 74
IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF GEORGIA ATLANTA DIVISION Civil Action No . 1:07-cv-2298
IN RE NETBANK, INC. SECURITIES LITIGATION
Jury Trial Demanded
CERTIFICATION Submitting Counsel hereby certifies that the text of the foregoing document has been prepared with Times New Roman 14 point, one of the fonts and point selections approved by the Court, and complies in all respects with Local Rule 5.1(C) of the United States District Court, Northern District of Georgia.
Dated : July 3 , 2008 Isf Michael J. Gorby Michael J. Gorby, Esq. Mary Donne Peters, Esq. GORBY, PETERS & ASSOCIATES, P.C. Two Ravinia Drive, Suite 1500 Atlanta, GA 30346-2104 Telephone: (404) 239-1150 Fax: (404) 239-1179
[email protected] [email protected]
Is/ Merrill G. Davidoff Merrill G. Davidoff, Esq. Michael Dell'Angelo, Esq. Lane L. Vines, Esq. BERGER & MONTAGUE, P.C. 1622 Locust Street Philadelphia, PA 19103 Telephone: (215) 875-3000 Fax: (215) 875-4604
[email protected] [email protected] [email protected]
Local Counselfor Lead Plaintiff Robert A. Brown and the Proposed Class
Lead Counselfop Lead Plaintiff Robert A. Brown and the Proposed Class
Case 1 : 07-cv-02298 -BBM
Document 35-3
Filed 07/03/2008
Page 73 of 74
IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF GEORGIA ATLANTA DIVISION
Civil Action No. 1:07-cv-2298 IN RE NETBANK, INC. SECURITIES LITIGATION Jury Trial Demanded
CERTIFICATE OF SERVICE This is to certify that I have this day served counsel for all parties in the foregoing matter with a copy of CONSOLIDATED AND AMENDED CLASS ACTION COMPLAINT with the Clerk of Court using the CM/ECF system, which will automatically send email notification of such filing to the following counsel of record: Michael R. Smith, Esq. Benjamin Lee, Esq. KING & SPALDING LLP 1180 Peachtree Street, N.E. Atlanta, Georgia 30309-3521 (404) 572-4600 (404) 572-5100 Fax mrsmith kslaw.com blee(kslaw.com Attorneys for Defendants
Case 1:07-cv-02298-BBM
Document 35-3
Filed 07/03/2008
Page 74 of 74
This 3rd day of July, 2008.
/s/ Michael J. Gorby Michael J. Gorby, Esq. Mary Donne Peters, Esq. GORBY, PETERS &
ASSOCIATES, P.C. Two Ravinia Drive, Suite 1500 Atlanta, GA 30346-2104 Telephone: (404) 239-1150 Fax: (404) 239-1179
[email protected] [email protected]
Local Counselfor Lead Plaintiff Robert A. Brown and the Proposed Class
Is/ Merrill G. Davidoff Merrill G. Davidoff, Esq. Michael Dell'Angelo, Esq. Lane L. Vines, Esq. BERGER & MONTAGUE, P.C.
1622 Locust Street Philadelphia, PA 1.9103 Telephone: (215) 875-3000 Fax: (215) 875-4604
[email protected] [email protected] [email protected] Lead Counsel for Lead Plaintiff Robert A. Brown and the Proposed Class
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