Compliance July 10, 2008

NovaStar Faces 401(k) Company Stock Suit

Participants claim NovaStar’s 401(k) plan was imprudently invested because of the company's alleged sub-prime mortgage lending practices.
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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.”

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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.

Compliance July 10, 2008

Federal Appellate Panel Clears Two More Cash Balance Plans

In a continuation of a recent trend of federal courts throwing aside cash balance plan challenges, a federal appellate court has cleared two more sponsors of wrongdoing.
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In separate cases involving Verizon Communications Inc. and Equitable Life Assurance Society—now known as AXA Equitable Life Insurance Co.—the 2nd U.S. Circuit Court of Appeals asserted that the companies’ cash balance plans did not discriminate against older workers.

Writing for the court, Circuit Judge Robert A. Katzmann said even before the June 29, 2005, effective date of a Pension Protection Act (PPA) provision blessing cash balance plans, they were still permissible under the Employee Retirement Income Security Act (ERISA). Katzmann, noting his court becomes the fourth federal appellate circuit to rule against the challenges, upheld lower court rulings in favor of the employers.

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“We write today to clarify that we share the view of cash balance plans put forth by the Third, Sixth, and Seventh Circuits: Even prior to the PPA, cash balance plans could survive scrutiny under ERISA,” Katzmann said.

As have other courts issuing cash balance rulings, the 2nd Circuit said the reason benefits provided to younger employees are worth more than the same benefits provided to older employees is the passage of time and compound interest, and such a difference does not constitute age discrimination.

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