NovaStar Faces 401(k) Company Stock Suit

While other firms are being sued for investing in sub-prime mortgage-backed securities, NovaStar Financial, Inc. is facing an Employee Retirement Income Security Act (ERISA) fiduciary breach suit over its alleged subprime mortgage lending practices.

In the suit filed in U.S. District Court for the Western District of Missouri, Jennifer Jones, on behalf of a class of participants in NovaStar’s 401(k) plan, alleges that fiduciaries of the plan allowed the imprudent investment of the plan’s assets in NovaStar common stock when they knew or should have known the investment was unduly risky and imprudent due to the company’s “serious mismanagement and improper business practices.”

Those improper business practices, according to the suit, include, among other things: relying on originating, purchasing, securitizing, selling, investing in and servicing subprime residential mortgages for revenue; manipulation of its mortgage origination process; and failing to abide by its stated mortgage underwriting process and criteria.

Jones alleged NovaStar also failed to abide by proper risk management processes, used improper financial accounting for its portfolio of mortgages, and engaged in practices that endangered, and ultimately eliminated, its ability to elect to be taxed as a real estate investment trust (REIT).

The suit said all of these practices caused NovaStar’s financial statements to be misleading and artificially inflated the value of its shares and the Company Stock Fund in the 401(k) plan, which caused millions of dollars of losses for participants during the class period. The suit seeks to recover those losses, among other things.

In addition to NovaStar, the complaint also names NovaStar’s chairman and CEO and members of its Retirement Committee as defendants.