More NovaStar Fallout

This post by Peter Cohan in bloggingstocks.com gives several reasons why NovaStar Financial may wind up as a penny stock. Pay particular attention to this one:

• Weak disclosure. While I am not an expert on mortgage accounting or disclosure requirements, one analyst who is said that NFI's financial disclosure was the "most difficult . . . that we have examined." For example, its 10K reveals that the value of NFI's mortgage loan portfolio is based on management's assumptions about current economic conditions, the makeup of the portfolio based on credit grade, loan-to-value, delinquency status, historical credit losses, whether NFI purchased mortgage insurance, etc. -- which are not made explicit to investors. Thus there is no way of knowing whether management used assumptions that artificially inflate its financial condition. One thing's for sure -- while NFI's top line -- interest income -- rose 54% to $495 million, its cash balance fell 43% in 2006. This is the sort of red flag that attracted James Chanos to Enron, who made a fortune shorting its stock.

NFI's weak disclosure leaves important questions unanswered. . .

... which he goes on to list. But to me, what he is describing is an excellent example why Sarbanes-Oxley is not the panacea for accounting mischief as it was billed in 2002. It did nothing to address the central problem, which is the tendency of some corporate managers to obfuscate, conceal and lie.

Another issue raised in Cohan's piece is the value of short-sellers to counteract management overenthusiasm.

NovaStar was the "beneficiary" (quote unquote) of a campaign by the anti-naked-shorting crowd, which set up an "independent" stock-pump website, created by naked-shorting fruitcake Phil Saunders, that vilified critics of this company.

The endless pumping on the site and in message boards turned NovaStar into a "cult stock" that sucked in untold numbers of small investors. Some were persuaded to put a substantial portion of their retirement savings in NovaStar, such as this investor cited by Cohan.

Every year sees new and better ways of ripping off investors, and the newest are what we saw at NovaStar -- pumper websites ostensibly unaffiliated with the stock issuer. NovaStar demonstrated that these can be just as damaging as traditional boiler-room pumping. Time for regulators to hone in on this problem and punish the people responsible.

© 2007 Gary Weiss. All rights reserved.
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