UNITED STATES DISTRICT COURT WESTERN DISTRICT OF MISSOURI WESTERN DIVISION ) ) ) ) ) ) ) ) ) ) ) ) ) No.

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1 UNITED STATES DISTRICT COURT WESTERN DISTRICT OF MISSOURI WESTERN DIVISION VERNON TICE, On Behalf of Himself and All Others Similarly Situated, vs. Plaintiff, NOVASTAR FINANCIAL, INC., W. LANCE ANDERSON, SCOTT F. HARTMAN and RODNEY E. SCHWATKEN, Defendants. No. CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS DEMAND FOR JURY TRIAL

2 SUMMARY AND OVERVIEW 1. This is a securities class action on behalf of all purchasers of the common stock of NovaStar Financial, Inc. ( NovaStar or the Company between October 29, 2003 and April 8, 2004 (the Class Period, against NovaStar and certain of its officers and directors for violations of the Securities Exchange Act of 1934 (the 1934 Act. 2. NovaStar is a specialty finance company that originates, invests in and services residential nonconforming loans. The Company operates through three separate but inter-related units: mortgage lending and loan servicing, mortgage portfolio management and branch operations. The Company offers a range of mortgage loan products to borrowers (nonconforming borrowers that generally do not satisfy the credit, collateral, documentation or other underwriting standards prescribed by conventional mortgage lenders and loan buyers, including government-sponsored entities such as Federal National Mortgage Association (Fannie Mae or Federal Home Loan Mortgage Corporation (Freddie Mac. NovaStar retains interests in the nonconforming loans it originates through its mortgage securities investment portfolio. Through its servicing platform, the Company then services all of the loans it retains interests in, in order to better manage the credit performance of those loans. During the Class Period, the Company s shares hit a high of $67 per share. The shares soared as the defendants continued to create the illusion that the number of its offices were growing and record results would follow. Desperate to create this illusion in order to finance the Company through stock sales, defendants even went so far as to actually overstate the number of offices NovaStar had together with operating offices illegally in multiple states. 3. The true facts which were known by each of the defendants, but concealed from the investing public during the Class Period, were as follows: (a That the Company s growth through branch office expansions was grossly overstated as these offices were illegally conducting business in Nevada and elsewhere; - 1 -

3 (b That the Company s projected growth would be thwarted once regulators unearthed the defendants unlawful business; (c That the Company actually exaggerated the number of its branches in existence; for example, the Company overstated the number of its Nevada branches by 120%; and (d That the full extent of defendants unlawful practices are only beginning to be known. In fact, it was just reported that none of the Company s branches in Texas are licensed to do business. 4. As a result of the defendants false statements, NovaStar s stock price traded at inflated levels during the Class Period, increasing to as high as $67 on March 22, 2004, whereby the Company sold more than $107 million worth of its shares to the unsuspecting public. 1 JURISDICTION AND VENUE 5. Jurisdiction is conferred by 27 of the 1934 Act. The claims asserted herein arise under 10(b and 20(a of the 1934 Act and Rule 10b (a Venue is proper in this District pursuant to 27 of the 1934 Act. Many of the false and misleading statements were made in or issued from this District. (b The Company s principal executive offices are in Kansas City, Missouri, where the day-to-day operations of the Company are directed and managed. THE PARTIES 7. Plaintiff Vernon Tice purchased NovaStar common stock as described in the attached certification and was damaged thereby. 1 All share amounts and per share prices have been adjusted for the Company s 2-for-1 stock split effective December 1,

4 8. Defendant NovaStar is a specialty finance company that originates, invests in and services residential nonconforming loans. The Company operates through three separate but interrelated units: mortgage lending and loan servicing, mortgage portfolio management and branch operations. The Company offers a range of mortgage loan products to borrowers (nonconforming borrowers that generally do not satisfy the credit, collateral, documentation or other underwriting standards prescribed by conventional mortgage lenders and loan buyers, including governmentsponsored entities such as Federal National Mortgage Association (Fannie Mae or Federal Home Loan Mortgage Corporation (Freddie Mac. NovaStar retains interests in the nonconforming loans it originates through its mortgage securities investment portfolio. Through its servicing platform, the Company then services all of the loans it retain interests in, in order to better manage the credit performance of those loans. 9. Defendant W. Lance Anderson ( Anderson was the President, COO and a director of NovaStar. 10. Defendant Scott F. Hartman ( Hartman was the Chairman of the Board and CEO of NovaStar. 11. Defendant Rodney E. Schwatken ( Schwatken was Vice President, Secretary, Treasurer and Controller of NovaStar. 12. The individuals named as defendants in 9-11 are referred to herein as the Individual Defendants. The Individual Defendants, because of their positions with the Company, possessed the power and authority to control the contents of NovaStar s quarterly reports, press releases and presentations to securities analysts, money and portfolio managers and institutional investors, i.e., the market. Each defendant was provided with copies of the Company s reports and press releases alleged herein to be misleading prior to or shortly after their issuance and had the ability and opportunity to prevent their issuance or cause them to be corrected. Because of their - 3 -

5 positions and access to material non-public information available to them but not to the public, each of these defendants knew that the adverse facts specified herein had not been disclosed to and were being concealed from the public and that the positive representations which were being made were then materially false and misleading. The Individual Defendants are liable for the false statements pleaded herein at 17-20, as those statements were each group-published information, the result of the collective actions of the Individual Defendants. SCIENTER 13. In addition to the above-described involvement, each Individual Defendant had knowledge of NovaStar s problems and was motivated to conceal such problems. Schwatken, as principal accounting officer, was responsible for financial reporting and communications with the market. Many of the internal reports showing NovaStar s forecasted and actual growth were prepared by the finance department under Schwatken s direction. Defendants Hartman, as CEO and Chairman, and Anderson, as President, were responsible for the financial results and press releases issued by the Company. Each Individual Defendant sought to demonstrate that he could lead the Company successfully and generate the growth expected by the market. 14. Defendants were motivated to engage in the fraudulent practices alleged herein in order to obtain financing for the Company. FRAUDULENT SCHEME AND COURSE OF BUSINESS 15. Each defendant is liable for (i making false statements, or (ii failing to disclose adverse facts known to him about NovaStar. Defendants fraudulent scheme and course of business that operated as a fraud or deceit on purchasers of NovaStar common stock was a success, as it (i deceived the investing public regarding NovaStar s prospects and business; (ii artificially inflated the price of NovaStar common stock; (iii allowed defendants to arrange to sell and actually sell in excess of $107 million worth of NovaStar shares at artificially inflated prices in two consecutive - 4 -

6 offerings of both common and preferred stock; and (iv caused plaintiff and other members of the Class to purchase NovaStar common stock at inflated prices. BACKGROUND 16. NovaStar is a specialty finance company that originates, invests in and services residential nonconforming loans. The Company operates through three separate but inter-related units: mortgage lending and loan servicing, mortgage portfolio management and branch operations. The Company offers a range of mortgage loan products to borrowers (nonconforming borrowers that generally do not satisfy the credit, collateral, documentation or other underwriting standards prescribed by conventional mortgage lenders and loan buyers, including government-sponsored entities such as Federal National Mortgage Association (Fannie Mae or Federal Home Loan Mortgage Corporation (Freddie Mac. NovaStar retains interests in the nonconforming loans it originates through its mortgage securities investment portfolio. Through its servicing platform, the Company then services all of the loans it retains interests in, in order to better manage the credit performance of those loans. DEFENDANTS FALSE AND MISLEADING STATEMENTS ISSUED DURING THE CLASS PERIOD 17. On October 29, 2003, the Company issued a press release entitled NovaStar Announces Third-Quarter Earnings Per Share of $[1.05], a Two-for-One Stock Split and Dividend of $[1.25]. The press release stated in part: NovaStar Financial, Inc., a residential mortgage lender and portfolio investor, today reported financial results for the third quarter of Highlights include: -- Significant growth in nonconforming loan production compared to previous quarters. -- Increase in securities portfolio of 12 percent versus the second quarter

7 -- Increase in NovaStar-affiliated branch offices of 20 percent from the second quarter. -- Two-for-one stock split -- Dividend of $[1.25] per share. -- Increase in combined, committed lending facilities to $3.1 billion. * * * NovaStar continues to deliver growth in earnings, production and our securities portfolio is shaping up as the best year yet for NovaStar, and we expect results to continue moving up in 2004, said Scott Hartman, Chief Executive Officer. Focusing on the nonconforming mortgage market is enabling NovaStar to keep growing, even as conventional lending slows following the recent increases in interest rates. Increased Earnings Guidance * * * NovaStar management now expects full-year 2003 earnings per diluted share in a range of $[4.00] to $[4.20], an increase from previous guidance of $[3.87] to $[4.12]. Furthermore, management expects that 2004 earnings will exceed 2003 results by between 5 and 10 percent. This outlook is based on projections that include future interest rates from the September 30, 2003, implied forward curve. It assumes that production levels will increase moderately on a sequential basis and that production costs will be similar to recent past experience. Future earnings and dividends will depend on actual interest rates, production growth, volume of loans sold and securitized, whole loan market prices, the amount, if any, of new capital raised, credit performance and options related expenses. Branch Network Continues Growth and Drives Nonconforming Production The NovaStar affiliated branch network increased to 420 branches as of September 30. The number of branch openings continues to exceed expectations, said Lance Anderson, President. We have been highly successful in developing productive branches across the country, which is driving growth in production and helping sustain our overall lending success. NovaStar originated $1.8 billion of mortgage loans in the third quarter, up from $1.5 billion in the second quarter of 2003 and $647 million in the third quarter of

8 In addition to opening a large number of new branches, the nationwide NovaStar loan origination network -- independent brokers, affiliated NovaStar branches, correspondent institutions and direct to consumer -- continues to grow. At the beginning of the year, we expected to produce $4 to $6 billion in loans during Given our first three quarters of production and our current monthly run-rate, we expect to be in the upper end of our initial range, Mr. Anderson said. * * * Liquidity and Borrowing Capacity NovaStar now has committed borrowing capacity of $3.1 billion. As of September 30, 2003, our cash and available liquidity exceeded $80 million. 18. On November 7, 2003, the Company issued a press release entitled NovaStar Financial, Inc. Prices an Offering of Common Stock. The press release stated in part: NovaStar Financial, Inc. announced today the public offering of [1,220,000] shares of its common stock at a public offering price of $[38.50] per share. The net proceeds to NovaStar are estimated to be approximately $44,914,000. The public offering is lead managed by JMP Securities LLC and co-managed by Flagstone Securities, LLC. In connection with the public offering, NovaStar has granted its underwriters an option, exercisable for 30 days, to purchase up to an additional [183,000] shares to cover over-allotments, if any. 19. On January 16, 2004, the Company issued a press release entitled NovaStar Financial, Inc. Prices an Offering of Preferred Stock. The press release stated in part: NovaStar Financial, Inc. announced today the pricing of 2,600,000 shares of Series C Cumulative Redeemable Perpetual Preferred stock. The shares have a liquidation value of $25.00 per share and will pay an annual coupon of 8.90%. The Company has granted its underwriters an option, exercisable for 30 days, to purchase up to an additional 390,000 shares to cover over-allotments, if any. The Company is raising funds in this offering to fund mortgage loans and for general corporate purposes. The offering is being lead-managed by Friedman, Billings, Ramsey & Co., Inc. Co-managers are Stifel, Nicolaus & Company, Incorporated, JMP Securities and Flagstone Securities. I am pleased with the amount and types of capital the Company has been able to raise over the past nine months and in particular the economic advantages of this preferred offering, said Scott Hartman, Chief Executive Officer

9 20. On January 28, 2004, the Company issued a press release entitled NovaStar Announces Fourth-Quarter Earnings Per Share of $1.38, Culminating a Record Year. The press release stated in part: NovaStar Financial, Inc., a residential mortgage lender and portfolio investor, reported net earnings of $33.7 million, or $1.38 per diluted share, for the fourth quarter of 2003, up from $17.3 million, or $0.81 per diluted share, in the fourth quarter of For the full year, NovaStar reported net earnings of $110.5 million, or $4.84 per diluted share, more than double the company s 2002 earnings of $48.8 million, or $2.25 per share (after adjustment for the two-for-one stock split effective December 1, Among highlights of the fourth quarter, NovaStar: -- Increased its mortgage securities portfolio 13.2 percent over the thirdquarter level and percent compared with year-end Achieved continued growth in nonconforming loan production, on top of record levels in the first three quarters of Expanded its network of NovaStar-affiliated branches to 432 at yearend. -- Declared a $1.25 per share common dividend and announced a new dividend policy designed to enhance shareholder value. In preparation for 2004, NovaStar has taken significant steps to prepare its balance sheet for continued growth in the mortgage securities portfolio, which drives interest income. In November 2003, the company raised $51.7 million in a follow-on offering, through the sale of 1.4 million common shares. Earlier this month, NovaStar raised $63 million through the placement of 2.6 million, 8.9 percent redeemable perpetual preferred shares. During the fourth quarter, NovaStar declared a dividend of $1.25 per common share payable on January 6, Also, NovaStar s Board of Directors adopted a new dividend policy in December, intended to reduce the need for new capital and better manage volatility in its dividend payments. NovaStar delivered its best results ever in Our focus is on sustaining growth for the long haul, and NovaStar has reached a scale and maturity that will serve us well in the future, said Scott Hartman, Chief Executive Officer. Our wholesale origination strategy and highly productive affiliated branches have been a strong competitive advantage. In 2004, we will emphasize continued growth in our branches, along with growing our other origination - 8 -

10 channels -- correspondent and retail lending -- through strategies that create advantages for NovaStar as we serve customers in these markets. Mr. Hartman added: While the interest rate environment is uncertain, we believe NovaStar will continue to grow faster than the nonprime market during Based on current market conditions, we expect to originate $6 billion to $8 billion of nonconforming mortgage loans in the current year. Nonconforming Mortgage Production at Record Levels Nonconforming mortgage production for the fourth quarter of 2003 was $1.59 billion, up 67 percent from $950 million in the fourth quarter of The fourth quarter was up 7 percent sequentially from $1.49 billion in the third quarter of Fourth quarter production brought our total nonconforming volume in 2003 to $5.25 billion, in line with what we projected at the beginning of the year. Our production levels continued strong through the fourth quarter, said Lance Anderson, President. We expect our origination activity to continue to increase in Affiliated branch originations again were a substantial driver of growth in wholesale production and the NovaStar portfolio. Branch production was $397.9 million in the fourth quarter, up 14.5 percent from third quarter production of $347.6 million. NovaStar ended the fourth quarter with 432 affiliated branch offices, up from 420 at the end of September and 216 at year-end Our strategy of growing wholesale by growing our affiliated branch network is working well, said Mr. Anderson. We expect to end 2004 with more than 600 branch offices. Mortgage Securities Portfolio Growth Continues During the fourth quarter, NovaStar securitized $1.67 billion in nonconforming mortgage loans, increasing our securities portfolio by $44.7 million, or 13.2 percent, compared with the third quarter. The year-end 2003 portfolio totaled $382.3 million, an increase of percent from year-end Growth in our securities portfolio is a key determinant of NovaStar s future earnings potential, said Mr. Hartman. Given our current monthly production run rate, we expect to see growth in our securities portfolio of 50 percent to 60 percent in Earnings Guidance NovaStar management believes 2004 diluted earnings per share will be in a range of $4.50 to $5.00. This outlook is based on projections that include future interest rates from the December 31, 2003, implied forward curve. This assumes production levels will increase moderately on a sequential basis and that production costs will be similar to recent past experience. Future earnings and - 9 -

11 dividends will depend on actual interest rates, production growth, volume of loans sold and securitized, whole loan market prices, the amount, if any, of new capital raised, credit performance and options related expenses. Liquidity and Borrowing Capacity NovaStar now has committed borrowing capacity of $2.9 billion. As of December 31, 2003, our cash and available liquidity exceeded $115 million. DEFENDANTS SCHEME BEGINS TO UNRAVEL 21. On April 12, 2004, Bloomberg issued a release entitled NovaStar s Nevada Woes Highlight Expansion Concerns, WSJ Says. The release stated in part: NovaStar Financial Inc. s legal troubles in Nevada, where regulators said the mortgage lender s branches weren t licensed to do business, highlight concerns that the company has grown too quickly to keep up its regulatory compliance, the Wall Street Journal reported. NovaStar, which makes home loans to people with poor credit, agreed to pay Nevada an $80,000 fine and was permitted to resume business in the state, pending a decision on its license applications, the newspaper said. Massachusetts also ordered NovaStar to cease operations there after its banking division found the company was doing business with an unlicensed broker, the paper said. It was allowed to resume business after paying a fine. The company also hasn t registered its branches in Texas, the paper said, citing the Texas Savings and Loan Department. NovaStar said it had 432 branches in 39 states as of Dec. 31, more than double the branches it had a year earlier, the Journal said. A NovaStar spokesman didn t immediately return a message Bloomberg News left seeking comment. 22. The true facts which were known by each of the defendants, but concealed from the investing public during the Class Period, were as follows: (a That the Company s growth through branch office expansions was grossly overstated as these offices were illegally conducting business in Nevada and elsewhere; (b That the Company s projected growth would be thwarted once regulators unearthed the defendants unlawful business; (c That the Company actually exaggerated the number of its branches in existence; for example, the Company overstated the number of its Nevada branches by 120%; and

12 (d That the full extent of defendants unlawful practices are only beginning to be known. In fact, it was just reported that none of the Company s branches in Texas are licensed to do business. COUNT I For Violation of 10(b of the 1934 Act and Rule 10b-5 Against All Defendants 23. Plaintiff incorporates 1-22 by reference. 24. During the Class Period, defendants disseminated or approved the false statements specified above, which they knew or deliberately disregarded were misleading in that they contained misrepresentations and failed to disclose material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. 25. Defendants violated 10(b of the 1934 Act and Rule 10b-5 in that they: (a (b Employed devices, schemes, and artifices to defraud; Made untrue statements of material facts or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or (c Engaged in acts, practices, and a course of business that operated as a fraud or deceit upon plaintiff and others similarly situated in connection with their purchases of NovaStar common stock during the Class Period. 26. Plaintiff and the Class have suffered damages in that, in reliance on the integrity of the market, they paid artificially inflated prices for NovaStar common stock. Plaintiff and the Class would not have purchased NovaStar common stock at the price they paid, or at all, if they had been aware that the market price had been artificially and falsely inflated by defendants misleading statements

13 27. As a direct and proximate result of these defendants wrongful conduct, plaintiff and the other members of the Class suffered damages in connection with their purchases of NovaStar common stock during the Class Period. COUNT II For Violation of 20(a of the 1934 Act Against All Defendants 28. Plaintiff incorporates 1-27 by reference. 29. The Individual Defendants acted as controlling persons of NovaStar within the meaning of 20(a of the 1934 Act. By reason of their positions as officers and/or directors of NovaStar, and their ownership of NovaStar stock, the Individual Defendants had the power and authority to cause NovaStar to engage in the wrongful conduct complained of herein. NovaStar controlled each of the Individual Defendants and all of its employees. By reason of such conduct, the Individual Defendants and NovaStar are liable pursuant to 20(a of the 1934 Act. CLASS ACTION ALLEGATIONS 30. Plaintiff brings this action as a class action pursuant to Rule 23 of the Federal Rules of Civil Procedure on behalf of all persons who purchased NovaStar common stock on the open market during the Class Period (the Class. Excluded from the Class are defendants. 31. The members of the Class are so numerous that joinder of all members is impracticable. The disposition of their claims in a class action will provide substantial benefits to the parties and the Court. NovaStar had more than 24 million shares of stock outstanding, owned by hundreds if not thousands of persons. 32. There is a well-defined community of interest in the questions of law and fact involved in this case. Questions of law and fact common to the members of the Class which predominate over questions which may affect individual Class members include: (a Whether the 1934 Act was violated by defendants;

14 (b (c Whether defendants omitted and/or misrepresented material facts; Whether defendants statements omitted material facts necessary to make the statements made, in light of the circumstances under which they were made, not misleading; (d Whether defendants knew or deliberately disregarded that their statements were false and misleading; (e (f Whether the price of NovaStar common stock was artificially inflated; and The extent of damage sustained by Class members and the appropriate measure of damages. 33. Plaintiff s claims are typical of those of the Class because plaintiff and the Class sustained damages from defendants wrongful conduct. 34. Plaintiff will adequately protect the interests of the Class and has retained counsel who are experienced in class action securities litigation. Plaintiff has no interests which conflict with those of the Class. 35. A class action is superior to other available methods for the fair and efficient adjudication of this controversy. PRAYER FOR RELIEF WHEREFORE, plaintiff prays for judgment as follows: A. Declaring this action to be a proper class action pursuant to FRCP 23; B. Awarding plaintiff and the members of the Class damages, interest and costs; and C. Awarding plaintiff reasonable costs and attorneys fees; and D. Awarding such equitable/injunctive or other relief as the Court may deem just and proper

15 Plaintiff demands a trial by jury. JURY DEMAND DATED: April 13, 2004 LAW OFFICE OF JOHN J. MILLER, P.C. JOHN J. MILLER (32215 JOHN J. MILLER 4770 North Belleview, Suite 202 Kansas City, MO Telephone: 816/ / (fax MILBERG WEISS BERSHAD HYNES & LERACH LLP WILLIAM S. LERACH DARREN J. ROBBINS 401 B Street, Suite 1700 San Diego, CA Telephone: 619/ / (fax ADEMI & O REILLY, LLP GURI ADEMI 3620 East Layton Avenue Cudahy, WI Telephone: 414/ / (fax OAKES & FOSHER, LLC BRUCE D. OAKES RICHARD B. FOSHER 1401 S. Brentwood Blvd., Suite 560 St. Louis, MO Telephone: 314/ / (fax Attorneys for Plaintiff