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Consolidated Class Action Complaint for Violation of the Federal Securities Laws
Source: Milberg Weiss Date: 06/17/02 Time: 9:38 AM
MILBERG WEISS BERSHAD HYNES & LERACH LLP JEFFREY W. LAWRENCE (166806) CHRISTOPHER P. SEEFER (201197) 100 Pine Street, Suite 2600 San Francisco, CA 94111 Telephone: 415/288-4545 415/288-4534 (fax) -and- WILLIAM S. LERACH (68581) 401 B Street, Suite 1700 San Diego, CA 92101 Telephone: 619/231-1058 619/231-7423 (fax)
BERNSTEIN LITOWITZ BERGER & GROSSMANN LLP ALAN SCHULMAN (128661) 12544 High Bluff Drive, Suite 150 San Diego, CA 92130 Telephone: 858/793-0070 858/793-0323 (fax) - and - DOUGLAS M. McKEIGE 1285 Avenue of the Americas 33rd Floor New York, NY 10019 Telephone: 212/554-1400 212/554-1444 (fax)
Co-Lead Counsel for Lead Plaintiffs and the Class
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
SAN JOSE DIVISION
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In re NEXTCARD, INC. SECURITIES ) Master File No. C-01-21029-JF(RS) LITIGATION ) ______) CLASS ACTION ) This Document Relates To: ) CONSOLIDATED CLASS ACTION ) COMPLAINT FOR VIOLATION OF THE ALL ACTIONS. ) FEDERAL SECURITIES LAWS ______)
TABLE OF CONTENTS
INTRODUCTION
JURISDICTION AND VENUE
THE PARTIES
CONFIDENTIAL WITNESSES
SUBSTANTIVE ALLEGATIONS
A. Description of the Company, Its Products and Business Strategy
B. NextCard Was Particularly Susceptible to the Risk of Adverse Selection
C. NextCard Lowers Its FICO Scores, Reports "Extremely Strong Results" and Falsely Reassures Analysts the Company's Credit Quality Was "Under Control"
D. NextCard Was Required to Report Its Financial Results in Accordance with GAAP and Comply with Regulatory Capital Requirements
DESCRIPTION OF DEFENDANTS' FRAUD
A. Defendants Caused the Company to Report Inflated Earnings by Failing to Establish Sufficient Loan Loss Allowances on Credit Card Receivables
B. Defendants Caused NextBank to Report Inflated Earnings and Capital by Improperly Capitalizing Credit Card Acquisition Costs
C. Defendants Caused the Company to Report Inflated Regulatory Capital Ratios by Improperly Excluding Sold Loans from Risk Weighted Assets
D. Defendants Made False and Misleading Statements About the Number of Customer Accounts
FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD
A. Defendants' False and Misleading Statements Regarding NextCard's 1Q00 Results
B. Defendant Lent Made False and Misleading Statements at the 6/26/00 UBS Warburg Global Financial
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Services Conference
C. Defendants' False and Misleading Statements Regarding NextCard's 2Q00 Results
D. The False and Misleading Statements Made in the 9/11/00 Press Release and Analyst Reports
E. Defendants' False and Misleading Statements Regarding NextCard's 3Q00 Results
F. The False and Misleading 11/2/00 Press Release Regarding the Company's First Annual Investor Day
G. Defendants' False and Misleading Statements Regarding NextCard's 4Q00 and F00 Results
H. Defendants' False and Misleading Statements Regarding NextCard's 1Q01 Results
I. The False and Misleading 6/26/01 Press Release Announcing NextCard Had Exceeded One Million Customers and Reaffirming the Strength of the Company's Online Credit Card Business Model
J. Defendants' False and Misleading Statements Regarding NextCard's 2Q01 Financial Results
DEFENDANTS ADMIT THE COMPANY'S ONLINE CREDIT CARD BUSINESS MODEL WAS A FAILURE, THAT THE COMPANY NEEDED TO ESTABLISH SUBSTANTIAL LOAN LOSS ALLOWANCES AND THAT THE COMPANY HAD IMPROPERLY EXCLUDED MORE THAN $1 BILLION OF LOANS FROM ITS BOOKS
FALSE FINANCIAL STATEMENTS
DEFENDANTS' INSIDER TRADING
CLASS ACTION ALLEGATIONS
CLAIM FOR RELIEF FOR VIOLATION OF SECTION 10(b) OF THE 1934 ACT AND RULE 10b-5 AGAINST ALL DEFENDANTS
CLAIM FOR RELIEF FOR VIOLATION OF SECTION 20(a) OF THE 1934 ACT AGAINST ALL DEFENDANTS
PRAYER FOR RELIEF
JURY DEMAND
INTRODUCTION
1. This is a securities class action against NextCard, Inc. ("NextCard" or the "Company") and several of its officers and directors for violations of the federal securities laws. This action is also brought under Fed. R. Civ. P. 23, seeking certification of a class of persons and entities who purchased NextCard securities between 4/19/00 and 10/30/01 (the "Class Period").
2. On 2/7/02, the Office of the Comptroller of Currency ("OCC") placed NextBank, NextCard's wholly owned banking subsidiary, into receivership. Prior to the closure of NextBank, NextCard was an Internet-based provider of consumer credit. Unlike other credit card originators, NextCard marketed credit
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cards solely through its website, www.NextCard.com, believing it was positioned to take advantage of the exponential growth of consumers using the Internet. On 5/19/99 the Company completed its IPO in which it sold 6.9 million shares of its common stock at $20 per share, raising net proceeds of approximately $127 million. On 12/14/99 the Company completed a follow-on offering in which it sold 4.5 million shares at $35.94 per share, raising net proceeds of approximately $153 million.
3. NextCard pursued an aggressive Internet advertising campaign in an attempt to grow and compete successfully in what the Company and analysts described as a "hotly competitive" industry where even established companies like Capital One, BankOne, Chase, MBNA and Providian were finding it difficult to grow. However, to be a successful credit card originator, NextCard also had to guard against "adverse selection," i.e., granting credit cards to noncreditworthy applicants. That risk was more pronounced for NextCard because it was solicited by applicants that responded to its Internet advertising. Historically, customers that solicited credit cards tended to have much higher losses than customers solicited by the credit card company.
4. Throughout the Class Period the defendants represented that NextCard's Internet credit card banking business was a success and that the Company was building a platform for a highly profitable business at a dramatic growth rate. In every quarterly earnings release issued during the Class Period, NextCard reported (1) "extremely strong results" that "exceeded consensus estimates," and (2) substantial increases in the number and amount of credit card loans. NextCard also represented that it applied "stringent credit and risk management standards" to its credit card loan portfolio and that the loan loss allowances established by the Company reflected its "conservative approach to loan reserves." The Company also represented in its SEC filings that its financial results were reported in accordance with Generally Accepted Accounting Principles ("GAAP") and that it was in compliance with regulatory capital requirements imposed by federal banking law.
5. Defendants claimed NextCard was able to control the adverse selection risks and pursue an aggressive growth strategy by limiting approvals to applicants with FICO scores above 700, maintaining sufficient loan loss allowances and segmenting accounts by each advertiser to determine what advertising relationships were producing poor quality accounts. However, the Company lowered required FICO scores to increase growth rates and reduce credit card acquisition costs. Despite defendants' bullish statements and the reported growth in accounts and loan balances, the Company also reported deteriorating credit quality that analysts expressed concern about throughout the Class Period. Defendants continually reassured analysts and investors that credit quality was "under control" and that the Company had established sufficient loan loss allowances.
6. Contrary to defendants' false representations, NextCard's credit quality was not under control and it failed to establish sufficient loan loss allowances. According to various former NextCard employees and the OCC, the Company's financial results reported in press releases, SEC filings, and regulatory "Call Reports" during the Class Period were false and misleading for several reasons. Earnings, capital and regulatory capital were materially overstated because the Company (1) failed to establish sufficient loan loss allowances, (2) improperly capitalized credit card acquisition costs and (3) improperly excluded more than $1 billion of securitized loans from risk weighted assets in violation of federal banking regulations. In addition, defendants improperly classified certain loan loss allowances as "fraud losses" and buried these charges in "other expenses" thereby misleading investors about the true credit quality of the Company's loans. Finally, while the defendants repeatedly assured investors that credit quality was under control, they concealed from investors contrary findings by the OCC during its first annual examination of NextBank that concluded in 9/00. The OCC determined that NextBank had failed to identify the extent of its credit quality problems and that NextBank's risk management policies and procedures were inadequate. As a result of the adverse examination findings, the OCC insisted NextCard and NextBank execute a capital
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assurance agreement on 10/26/00. The capital assurance agreement required NextCard to maintain NextBank's regulatory capital at 12% of risk weighted assets - 50% more than the 8% required by federal banking regulations. The OCC also required the Board of Directors to adopt a detailed resolution that was designed to correct the deficiencies discovered during the 2000 examination. The capital assurance agreement and adverse examination findings were not disclosed to investors until after the Class Period.
7. Throughout the remainder of the Class Period, defendants concealed the OCC's adverse examination findings and the 10/26/00 capital assurance agreement. They continued to issue bullish statements about the Company's business, repeatedly assured analysts and investors that credit quality was under control and told investors that the Company would be profitable no later than 4Q01. Defendants knew those statements were materially false and misleading.
8. In 5/01 the OCC began its second annual examination of NextBank and discovered that the problems noted during the prior examination had not been corrected. In fact, the OCC determined that the Company was operating in an unsafe and unsound manner and had experienced a substantial dissipation of assets and earnings through unsafe and unsound practices. Further, the OCC found that the unsafe and unsound practices were likely to deplete all or substantially all of NextBank's capital and that there was no reasonable prospect for NextBank to become adequately capitalized without federal assistance.
9. Defendants caused the Company to report materially false and misleading financial results in order to report that it was in compliance with regulatory capital requirements. Failure to maintain minimum regulatory capital requirements would subject the Company to various regulatory restrictions including the closing of NextBank by the OCC.
10. Defendants also sold nearly $7 million worth of their own NextCard shares at prices as high as $10.89 per share, or 12 times the price to which NextCard shares dropped as NextCard's true prospects began to reach the market. All of the sales were in 2001, after the OCC insisted upon the 10/26/00 capital assurance agreement that was concealed from investors. Many of the sales occurred during or after the second OCC examination of NextBank that led to the closure of the bank.
11. After issuing nothing but extremely bullish statements about all facets of the Company's business, defendants blindsided investors on 10/31/01 when NextCard issued a press release announcing, inter alia, that it was (1) substantially increasing loan loss allowances, (2) tightening underwriting criteria by limiting new account originations to FICO scores above 680, (3) suspending other lending activities, (4) reclassifying previously recognized fraud losses as credit losses and (5) increasing risk weighted assets by more than $500 million because the Company's securitizations did not qualify for "low level recourse treatment." As a result of these actions, the Company disclosed that it was in violation of regulatory capital requirements and subject to "prompt corrective action" under applicable federal banking law. The Company also announced it had retained Goldman, Sachs & Co. ("Goldman Sachs") to explore a sale of the Company.
12. These disclosures shocked the market, causing NextCard's stock to decline 84% to $0.87 per share on 10/31/01 on volume of more than 43 million shares, inflicting millions of dollars of damages on plaintiffs and the class. Defendants' misconduct has wiped out over $800 million in market capitalization as NextCard stock has fallen 95% from its Class Period high of over $16 per share as the truth about NextCard, its operations and prospects began to reach the market.
13. The following chart illustrates the inflation of the Company's stock price during the Class Period and the collapse of the Company's stock price following the adverse disclosures on 10/31/01:
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14. Defendants' fraud had a devastating impact on the Company. Goldman Sachs was unable to find a buyer for the Company. On 2/7/02 the OCC closed NextBank and appointed the FDIC as Receiver after finding that NextBank (1) was operating in an unsafe and unsound manner, (2) had experienced a substantial dissipation of assets and earnings through unsafe and unsound practices, and (3) could not become adequately capitalized or pay its obligations (including meeting the demands of its depositors) without federal assistance. Shortly thereafter, the Company cut staff by 90% and laid off more than 500 employees. The Company discontinued banking operations, reported a staggering $232 million net loss for the year ending 12/31/01, and is now insolvent. The Company's stock has been delisted from the NASDAQ market and currently trades at just pennies per share.
15. Analysts' reaction to the Company's 10/31/01 press release demonstrates their belief that defendants made false and misleading statements during the Class Period. On 11/1/01, Deutsche Banc Alex. Brown, Inc. ("Deutsche Banc") analyst Richard Zandi issued a scathing report stating that management had "obvious credibility problems" and had "misled" when they previously insisted the Company was operated on a conservative basis with high credit quality and conservative accounting. In addition to this suit, the OCC and FDIC have initiated separate investigations into the events leading up to the closure of NextBank.
JURISDICTION AND VENUE
16. The claims asserted herein arise under §§10(b) and 20(a) of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. §§78j(b) and 78t(a), and Rule 10b-5. Jurisdiction is conferred by §27 of the 1934
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Act, 15 U.S.C. §78aa.
17. Venue is proper here pursuant to §27 of the 1934 Act. The acts and transactions giving rise to the violations of law complained of occurred here.
THE PARTIES
18. M. Richard Andrews and the Jacksonville Police & Fire Pension Fund are the Court appointed co-lead plaintiffs.
19. Defendant NextCard was an Internet-based provider of consumer credit. The Company offered an online credit approval system for a Visa card and provided interactive, customized offers for credit card applicants. NextCard operated in the United States. During the Class Period, NextCard had approximately 53 million shares of common stock outstanding, which shares traded in an efficient market on NASDAQ. NextCard operated through its wholly owned banking subsidiary, NextBank.
20. According to the Company's SEC filings, defendant John V. Hashman was the Company's CFO from 8/97 to 3/00, and president and CFO from 3/00 to 8/00. From 8/00 through the end of the Class Period, Hashman was president, CEO and a director of the Company. Prior to working at NextCard, Hashman was a vice president of direct telemarketing at Providian Bancorp., a direct marketing credit card issuer. Per the Company's bylaws, as CEO Hashman was the managing officer of the Company and had general supervision, control and management of the affairs and business of NextCard, and general charge and supervision of all officers and employees. As president, the Company's bylaws empowered Hashman to direct the day-to-day affairs and business of the Company. The Company's bylaws required the CFO to maintain accurate books and records of the Company. Hashman was quoted in numerous press releases and signed several of the Company's SEC filings. He signed the 10/26/00 capital assurance agreement insisted upon by the OCC after its first annual examination uncovered various problems concerning the Company's operations. He made presentations and statements to analysts that were repeated to the market in reports issued by analysts. In 2000, Hashman received a salary of $230,000, a $240,000 bonus and 1.35 million stock options. In 2001, he received a salary of $339,571 and a bonus of $240,000. Hashman was a member of the Company's credit committee which, according to the Company's SEC filings, was responsible for administering NextCard's written credit policies and regularly reviewing actual credit performance compared to plan. Witnesses have informed plaintiffs that Hashman and defendant Yinzi Cai controlled everything at NextCard. Hashman sold 35,800 shares of NextCard stock at artificially inflated prices as high as $10.00 per share for proceeds of more than $320,000.
21. According to the Company's SEC filings, defendant Yinzi Cai was the Company's senior vice president, decision analytics from 2/99 to 8/00, the Company's general manager of the credit card business from 8/00 to 2/01 and the Company's president and COO from 2/01 through the end of the Class Period. As president, the Company's bylaws empowered Cai to direct the day-to-day affairs and business of the Company. She was also a member of the Company's credit committee. Prior to joining NextCard, Cai was a principal in Finance Industry Group of America where she focused on risk management and direct marketing strategies for financial institutions. As detailed herein, Cai was quoted in some of the Company's press releases. In 2000, she received a salary of $188,830, a $100,000 bonus and 700,000 stock options. In 2001 she received a salary of $301,847, a $210,000 bonus and 250,000 stock options. Cai sold 47,637 shares of NextCard stock at artificially inflated prices as high as $9.63 per share for proceeds of more than $422,000.
22. According to the Company's SEC filings, defendant Jeremy R. Lent co-founded NextCard with his wife in 6/96 and served as the Company's chairman of the board and CEO from inception through 8/00,
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when he was appointed chairman of the board and chief strategy officer. Prior to co-founding NextCard, Lent was CFO of Providian Bancorp. Per the Company's bylaws, as CEO Lent was the managing officer of the Company and had general supervision, control and management of the affairs and business of NextCard, and general charge and supervision of all officers and employees. As chairman of the board, the Company's bylaws empowered Lent to preside at all meetings of stockholders and directors and made Lent an ex-officio member of standing committees. Lent was a member of the credit committee. As detailed herein, Lent was quoted in various press releases issued by the Company, signed several of the Company's SEC filings and made presentations and statements to analysts that were repeated to the market in reports issued by the analysts. In 2000, Lent received a salary of $338,462, a $350,000 bonus and owned more than four million shares of the Company's stock. In 2001 Lent received a salary of $337,005 and a $350,000 bonus. Lent sold 635,000 shares of NextCard stock at artificially inflated prices as high as $10.89 per share for proceeds of more than $5.5 million.
23. According to the Company's SEC filings, defendant Safi U. Qureshey was a director of the Company and a member of the audit committee and compensation committee. He was also a consultant to the Company and provided services related to NextCard's early stage financing efforts. Qureshey sold 74,610 shares of NextCard stock at artificially inflated prices as high as $10.54 per share for proceeds of more than $570,000.
24. According to the Company's SEC filings, defendant Bruce G. Rigione has been a director since 3/97 and was the Company's senior vice president of business development from 7/99 to 8/00. From 8/00 through the end of the Class Period Rigione was the Company's CFO. The Company's bylaws required the CFO to maintain accurate books and records of the Company. As CFO, Rigione signed many of the Company's SEC filings. Rigione was a member of the credit committee. In 2000, Rigione received a salary of $188,398. In 2001, he received a salary of $201,721 and an $80,000 bonus.
25. According to the Company's SEC filings, Robert Linderman was the Company's general counsel and secretary. Witnesses have informed plaintiffs that Linderman was aware of the OCC's examination findings and the 10/26/00 capital assurance agreement. Linderman sold 10,000 shares of NextCard stock at artificially inflated prices for $96,110.
26. Defendants are liable for the false statements contained in press releases and SEC filings as those statements were each "group-published" information for which they are responsible. Defendants Lent, Cai, Hashman, Rigione, Linderman and Qureshey (the "Individual Defendants"), were directly involved in the day-to-day operations of the Company at the highest levels, were privy to confidential propriety information concerning the Company and its business, operations, products, growth, financial statements, and financial condition, as alleged herein. The Individual Defendants by reason of their stock ownership and positions with NextCard as officers and/or directors, were controlling persons of NextCard. NextCard in turn controlled the Individual Defendants. The Individual Defendants and NextCard are liable under §20(a) of the 1934 Act.
27. All defendants, because of their positions with the Company, controlled and/or possessed the authority to control the contents of NextCard's reports, press releases and presentations to securities analysts and through them, to the investing public. The defendants were 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. Thus, each of the defendants had the opportunity to commit the fraudulent acts alleged herein.
28. As officers, directors and controlling persons of a publicly held company whose common stock was, and is, registered with the SEC pursuant to the 1934 Act, traded on the NASDAQ, and governed by the
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provisions of the federal securities laws, all defendants each had a duty to disseminate promptly accurate and truthful information with respect to the Company's financial condition and performance, growth, operations, financial statements, business, products, markets, management, earnings and present and future business prospects, and to correct any previously issued statements that had become materially misleading or untrue, so that the market price of the Company's common stock would be based upon truthful and accurate information. The defendants' misrepresentations and omissions during the Class Period violated these specific requirements and obligations.
CONFIDENTIAL WITNESSES
29. Confidential witness ("CW") 1 was a vice president of risk management from 9/00 until after the Class Period. CW1 was closely involved with the underwriting process and credit guidelines that NextCard used to evaluate potential customers. CW1 also is knowledgeable about how NextCard calculated loan loss allowances and how the Company differentiated between credit losses and fraud losses. CW1 also was involved in several meetings with the OCC in 2000 and 2001 and has knowledge about the OCC's examination findings.
30. CW2 was a file transmission specialist at NextCard from 1999 until after the Class Period. CW2 was responsible for entering cardholder account write-off data into a Company database. CW2 received monthly email messages from NextCard's fraud manager and collections manager that provided the accounts to be written off. CW2 assigned a "reason code" to each account written off that indicated whether the write-off was a credit loss or fraud loss.
31. CW3 was a former chief marketing officer through 9/00.
32. CW4 was NextCard's former head of public relations through 3/01.
33. CW5 was a former NextCard manager throughout the Class Period. CW5's job responsibilities included, among other things, consolidating reports to reconcile loan loss reporting. In 5/01, CW5 prepared reports that were provided to the OCC detailing the number of customer accounts with FICO scores below 660. CW5 was also involved in a major re-pricing and penalty pricing initiative during 2Q01 whereby the Company increased the interest rates and late fees on all existing customer accounts. CW5 stated that the pricing initiatives were atypically rushed through without the benefit of an analysis to determine what the response would be in order to increase revenues in 2Q01. CW5 stated NextCard lost customers due to these actions.
34. CW6 was a NextCard operations planning manager through 7/00. CW6 reported to COO Tim Coltrell who reported to defendant Cai. CW6 stated that NextCard did not close customer accounts after a customer asked for the account to be closed. CW6 stated the delay in closing customer accounts was done to increase the number of open accounts and that CW6 believed the practice was done to deceive shareholders into thinking the Company had more open accounts.
35. CW7 was a NextCard director of customer service or operations support throughout the Class Period.
36. CW8 was a NextCard collections representative throughout the Class Period. CW8 worked in the Company's collections department and was responsible for contacting delinquent customers and fielding customer complaints. CW8 stated that customers complained about NextCard increasing interest rates on their credit cards after an initial period during which the interest rate was much lower.
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SUBSTANTIVE ALLEGATIONS
A. Description of the Company, Its Products and Business Strategy
37. Prior to being placed in receivership, NextBank was an Internet based provider of consumer credit cards. Unlike other credit card originators, NextCard marketed credit cards solely through its website, www.NextCard.com, believing it was positioned to take advantage of the exponential growth of consumers using the Internet. Analysts following the Company reported (and NextCard represented in its SEC filings) that NextCard operated in a "hotly competitive" industry where even established companies like Capital One, BankOne, Chase, MBNA, and Providian were finding it difficult to grow.
38. To successfully compete against these companies and become profitable, NextCard had to grow. Therefore, NextCard (1) pursued an aggressive Internet advertising campaign, (2) provided an easy and quick application process whereby a potential customer could complete an application and receive a response within seconds, (3) offered initial teaser rates on its credit cards, and (4) offered approved accounts other perks including balance transfer services, customization of the face of the card according to personal preferences, e-wallet services and NextCard rewards. Through strategic alliances with other companies like Priceline.com and Amazon.com, the Company also offered cards to those companies' customers. NextCard securitized and sold a majority of its credit card receivables. As shown in the table below, NextCard reported increasing levels of accounts and managed loans from 6/30/99 to 6/30/01:
6/30/99 9/30/99 12/31/99 3/31/00 6/30/00 9/30/00 12/31/00 Accounts 85,000 134,000 220,000 337,000 443,000 577,000 708,000 Managed Loans (in millions) $163.4 $268.0 $416.3 $638.8 $829.7 $1,093.4 $1,312.3
3/31/01 6/30/01 9/30/01 Accounts 881,000 1,020,000 1,200,000 Managed Loans (in millions) $1,594.6 $1,789.4 $2,010.3
39. As detailed herein, throughout the Class Period, NextCard also (1) reported "extremely strong" quarterly earnings that beat consensus estimates, (2) represented that its Internet credit card business model was a success, (3) represented that the Company would be profitable by 4Q01 and (4) repeatedly assured analysts and investors that the Company's credit quality was "under control."
B. NextCard Was Particularly Susceptible to the Risk of Adverse Selection
40. While there is no back-end risk in selling products like books or CDs, credit card companies like NextCard must carry the risk burden of its customers into the future. Indeed, analysts reported that credit card assets were valued based on the credit quality of the receivables. Thus, to be successful, a credit card originator such as NextCard had to guard against "adverse selection," i.e., granting credit cards to non-creditworthy customers while it pursued its aggressive growth strategy. That risk was even more pronounced for NextCard because it was solicited by customers that responded to its Internet advertising. Historically, customers that solicited a credit card company for a card tended to have much higher losses than customers solicited by the credit card company.
41. Defendants claimed NextCard was able to control the adverse selection risks and pursue an aggressive growth strategy by limiting approvals to applicants with FICO scores above 700 and maintaining sufficient loan loss allowances and segmenting accounts by each advertiser to determine what advertising relationships were producing poor quality accounts. That strategy resulted in low approval rates (approximately 20%) and prohibitively high account origination costs which in turn, hindered growth and profitability. Before the Class Period, analysts reported that NextCard lowered required FICO scores
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in order to lower acquisition costs and increase growth. Witnesses also stated that FICO scores were loosened to be more aggressive. Although NextCard reported growth that exceeded expectations, analysts remained cautious about the prospects for the Company because of its limited operating history, high acquisition costs and deteriorating credit quality.
42. For example, on 1/10/00, First Union Securities, Inc. ("First Union"), analyst Meredith Whitney downgraded the stock from "Strong Buy" to "Hold" because its acquisition costs to date had been prohibitively high, making profitability difficult. She also noted that NextCard's inability to sign a sub-prime alliance could force the Company to issue sub-prime credit cards on its own. Whitney also noted that NextCard's alliances with Priceline.com and Amazon.com could squeeze NextCard into lowering FICO scores to increase approval rates to avoid upsetting their alliance partners. CIBC World Markets Corp. ("CIBC") analyst Vincent Daniel mirrored those concerns in a report issued on 1/10/00. Daniel stated the Company's recently announced co-branding relationship with Priceline.com could be problematic because a large portion of Priceline.com's customers had FICO scores below NextCard's standards, and because the acquisition cost per Priceline.com customer would be high at $100 to $120.
C. NextCard Lowers Its FICO Scores, Reports "Extremely Strong Results" and Falsely Reassures Analysts the Company's Credit Quality Was "Under Control"
43. On 1/28/00, Whitney issued another report after NextCard's "extremely bullish" conference call regarding 4Q99 and F99 financial results. Nevertheless, she maintained the "Hold" rating due to management's announcement that it intended to enter the non-prime market and the Company's deteriorating credit quality trends. CIBC analyst Daniel issued a report on 1/27/00 that stated charge-offs and delinquencies on a 12-month lagging basis that had deteriorated to 9.43% and 9.33% were "well above industry standards," a "red flag" and "cause for concern."
44. Prior to the beginning of the Class Period, NextCard's stock price declined from $27-7/8 on 12/31/99 to $15-7/8 on 3/31/00. Throughout the Class Period, NextCard issued bullish press releases announcing "extremely strong results." Analysts issued reports repeating defendants' bullish statements but also repeatedly noted their concerns about the deteriorating credit quality of the Company's growing credit card portfolio. Defendants responded to the concerns by assuring NextCard's credit quality was under control. The following table illustrates the Company's deteriorating credit quality.
6/30/99 9/30/99 12/31/99 3/31/00
Amount % of Total Amount % of Total Amount % of Total Amount % of Total
Managed Loans $163.4 100% $268 100% $416.3 100% $638.8 100% (in millions)
Delinquent Loans (000s) 31-60 $951 0.58% $1482 0.55% $2620 0.63% $4624 0.72% 61-90 $445 0.27% $677 0.25% $1692 0.41% $3236 0.51% >91 $563 0.35% $938 0.35% $1844 0.44% $3805 0.59% TOTAL $1959 1.2% $3,097 1.15% $6156 1.48% $11,665 1.82% Charge-offs (000s) $426 $915 $1569 $2554 % of Average Managed Loans 1.34% 1.72% 1.88% 1.93%
6/30/00 9/30/00 12/31/00 3/31/01
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Amount % of Total Amount % of Total Amount % of Total Amount % of Total
Managed Loans $829.7 100% $1,093.4 100% $1,312.3 100% $1,594.6 100% (in millions)
Delinquent Loans (000s) 31-60 $8665 1.04% $13,374 1.22% $18858 1.44% $23,084 1.45% 61-90 $5120 0.62% $8067 0.74% $13401 1.02% $17,481 1.10% >91 $8491 1.02% $14626 1.34% $19148 1.46% $35,127 2.20% TOTAL $22,276 2.68% $36,067 3.30% $51,407 3.92% $75,692 4.75% Charge-offs (000s) $4080 $6425 $9347 $14,709 % of Average Managed Loans 2.21% 2.67% 3.1% 3.99%
6/30/01 9/30/01
Amount % of Total Amount % of Total
Managed Loans $1789.4 500% $2,010.3 100% (in millions)
Delinquent Loans (000s) 31-60 $26225 1.46% $33962 1.69% 61-90 $22196 1.24% $26891 1.34% >91 $45599 2.55% $57740 2.87% TOTAL $94020 5.25% $118,593 5.9% Charge-offs (000s) $20,665 $37,186 % of Average Managed Loans 4.92% 7.89%
D. NextCard Was Required to Report Its Financial Results in Accordance with GAAP and Comply with Regulatory Capital Requirements
45. NextCard was required to maintain sufficient loan loss allowances on its credit card receivables. Specifically, FASB Statement of Financial Accounting Standard ("SFAS") No. 5, SEC Regulation S-X (17 C.F.R. §210.4-01(a)(1)), SEC Staff Accounting Bulletin ("SAB")102 and federal banking regulations required NextCard to maintain sufficient loan loss allowances and to report its financial results in accordance with GAAP.
46. As a federally insured financial institution, NextBank also had to maintain minimum levels of regulatory capital. Federal banking regulations (12 C.F.R. Part 3) required all banks to maintain regulatory capital equal to 8% of risk weighted assets. Banking regulations also required loans sold with recourse to be included in risk weighted assets. However, if a bank contractually limited its risk of loss or recourse exposure to less than the full amount of the loans sold (generally 8%), it was only required to include the amounts of retained recourse in risk weighted assets. See Appendix A, §3(b)(1)(iii) to 12 C.F.R. Part 3 and Call Report Instructions for lines 50 and 51 to Schedule RC-R.
47. Failure to comply with minimum regulatory capital requirements subjected a federally insured financial institution to restrictions, prohibitions and affirmative actions imposed by the OCC pursuant to its prompt corrective action powers. 12 C.F.R. Part 6. A bank's failure to recapitalize after receiving a PCA directive could result in the bank being placed into receivership.
48. On 10/26/00, NextCard and NextBank entered into a capital assurance agreement at the insistence of the OCC, requiring NextCard to ensure that NextBank's risk-based capital remained above 12% of risk
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weighted assets - 50% greater than required by law. The OCC insisted on the capital assurance agreement because it discovered during its first annual examination that (1) NextBank's risk management policies and procedures were inadequate, (2) the bank's assets were of lower credit quality than initially projected in the bank's business plan, (3) NextBank had failed to identify the extent of its credit quality problems and (4) NextBank had failed to implement effective corrective measures. While all of these issues went directly to the heart of NextCard's success, neither the adverse examination findings nor the capital assurance agreement were disclosed until after the Class Period. In fact, the day before defendant Hashman signed the agreement, NextCard issued a press release announcing "extremely strong results" for 3Q00 and representing that the Company took a "conservative approach to loan reserves." These statements were patently false.
49. In addition to the above capital ratios, the OCC has required that for the first three years of operations, NextBank maintain a ratio of stockholders' equity plus the allowance for loan losses to total managed assets of no less than 6.5% During the Class Period NextBank claimed it was in compliance with this capital requirement.
50. During the Class Period, NextBank reported it was "well capitalized" in all regulatory capital ratio categories. As a result, the Company achieved favorable treatment resulting in favorable adjustments to its at-risk accounts. This in turn entitled NextCard to a lower cost of funds and created the fiction of lower losses than defendants had led the public to believe. The Company obtained this favorable "well capitalized" status by falsifying the value of its receivables and manipulating its credit losses.
DESCRIPTION OF DEFENDANTS' FRAUD
51. Throughout the Class Period, NextCard reported increasing levels of originated accounts and managed loans but deteriorating credit quality. On numerous occasions defendants falsely represented that (1) credit quality was under control, (2) the Company had sufficient loan loss allowances, (3) the Company's financial results were reported in accordance with GAAP, SEC rules and federal banking regulations, and (4) the Company's capital levels met regulatory requirements. Defendants caused NextCard to report false and misleading financial results by (1) failing to establish sufficient loan loss allowances, (2) improperly capitalizing credit card acquisition costs, (3) improperly classifying certain loan loss allowances as "fraud" losses and (4) improperly excluding more than $1 billion of sold loans from risk weighted assets. They failed to disclose the capital assurance agreement or the OCC's adverse examination findings that led the OCC to insist on the capital assurance agreement.
A. Defendants Caused the Company to Report Inflated Earnings by Failing to Establish Sufficient Loan Loss Allowances on Credit Card Receivables
52. During the Class Period, defendants repeatedly assured investors that NextCard had established sufficient loan loss allowances on its credit card portfolio. Those representations were false and misleading.
53. During its 2000 examination that began in the summer of 2000 and concluded in approximately 9/00, the OCC determined that (1) NextBank's risk management policies and procedures were inadequate, (2) the bank's assets were of lower credit quality than initially projected in the bank's business plan, (3) NextBank had failed to identify the extent of its credit quality problems and (4) NextBank had failed to implement effective corrective measures. At the OCC's insistence, NextBank's board of directors adopted a detailed resolution on 10/26/00 that was designed to correct these deficiencies, maintain certain capital levels and to develop a capital plan. Per an undisclosed 10/26/00 capital assurance agreement insisted upon by the OCC, NextCard agreed to maintain NextBank's risk-based capital above 12% of risk weighted
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assets until a capital plan had been adopted by the bank's board of directors.
54. The OCC's 2001 examination began in 5/01 and concluded that NextBank failed to correct the deficiencies noted in the 2000 examination, was operating in an unsafe and unsound manner and had experienced a substantial dissipation of assets and earnings through unsafe and unsound practices. The OCC determined that NextBank needed to establish significant additional loan loss allowances. According to the Company's 10-Q for the quarter ending 9/30/01, NextBank incurred a $55.5 million expense which caused its loan loss allowances to more than double to $71.6 million.
55. In addition to the OCC's findings, plaintiffs have been informed by several witnesses that the Company failed to establish sufficient loan loss allowances. Two former high ranking officials at NextCard (CW3, a former chief marketing officer, and CW4, former head of public relations) confirmed that NextCard lowered required FICO scores in 3/00 and was having problems with collections. CW1, NextCard's former vice president of risk management, also stated that the Company's underwriting criteria loosened considerably from 9/00 through the end of the Class Period, due to a conscious decision to be more aggressive. As set forth in ¶44, the Company's delinquencies increased substantially throughout the Class Period after NextCard loosened underwriting criteria to increase growth.
56. In response, the Company established a collections task force in the summer of 2000 headed up by COO Tim Coltrell and later by Chris Hamilton, NextCard's vice president of credit who joined the Company in 4Q00. According to CW3 and CW4, task force member Rebecca Miller said that one of the Company's alliance partners was generating as much as 25% of the Company's originations and that, more often than not, the loans were of poor credit quality. CW3 and CW4 and a third witness (CW7, a former NextCard director of operations) said that there was tension between Coltrell and defendant Cai. Coltrell, tasked with the responsibility of collecting the increasing level of delinquent accounts, claimed Cai was allowing poor quality loans. Indeed, the former head of public relations and the former chief marketing officer both stated that the Company attempted to characterize the growing delinquencies as a collection problem rather than an underwriting problem (which it was).
57. CW3 and CW4 confirmed that the OCC believed there were credit problems at NextCard as early as 10/00 when the OCC insisted upon the capital assurance agreement. Both individuals also stated that they had discussions with several NextCard employees in late 2000 who expressed concern about the bank's loan loss allowances. For example, Scott Lascelless, NextCard's former vice president of customer management told the former chief marketing officer that NextCard's credit quality and charge-offs were "getting out of hand" and that things were going to "blow up." Chris Hamilton, vice president of credit, told the former head of public relations that in late 2000 he had concerns about the Company's loan loss allowances and charge-offs.
58. The problems continued in 2001. CW5, a former NextCard manager informed plaintiffs that by 5/01 the Company had 200,000 to 300,000 subprime accounts with FICO scores below 660. The former manager stated that that level of subprime accounts comprised a significant portion of the Company's receivables, constituting 20%-30% of the Company's active accounts (approximately one million accounts). CW1 confirmed that the level of subprime accounts comprised 30% of active accounts and that the level doubled from 9/00 to 9/01. The OCC discovered the significant level of subprime loans when it requested and received a listing of all the accounts with FICO scores below 660 in approximately 5/01 - when it began the examination that led to the closure of the bank.
59. CW2, the former NextCard file transmission specialist who was responsible for manually keying NextCard's customer account write-offs into the computer system, stated that the number of accounts written off "exploded" from approximately 100 customers per month to approximately 2,000 customers
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per month from 2/00 to 7/01.
60. The Company's methodology for calculating loan loss allowances was flawed. According to CW1, the Company determined loan loss allowances by calculating a rolling average percentage of historical credit loss write-offs and applying that percentage to the current portfolio. However, defendants knew that methodology understated required loan loss allowances because the Company loosened underwriting criteria and approved loans to applicants with sub-prime FICO scores. In short, the loss experience on older and higher quality loans was not an accurate predictor for newer lower quality loans.
61. Witnesses also stated that NextCard, and specifically defendant Hashman, aggressively managed earnings and always reported financial results that met or exceeded street estimates. According to witnesses and the Company's SEC filings, defendants Hashman, Cai, Lent and Rigione, and Hamilton and COO Coltrell were members of the Company's credit committee that determined the amounts of loan loss allowances to be established and whether to classify the losses as credit losses or fraud losses. However, the witnesses stated that defendants Hashman and Cai controlled everything at NextCard. They also stated that Jim Colroz was hired by defendant Hashman to maintain NextCard's books and told the board of directors in 2001 that defendant Cai's numbers for loan loss allowances were wrong and that she was lying.
62. Other former NextCard employees also informed plaintiffs that defendants Hashman and Cai caused NextCard to understate loan loss allowances by improperly classifying credit losses as fraud losses. According to CW1, a former vice president of risk management, and CW5, Hashman and Cai made the decision to classify certain loan losses as fraud losses. CW1 said that NextCard classified loan losses as fraud losses in three circumstances: first payment defaults; challenged bankruptcies; and "skips," i.e., customers that disappeared. This witness estimated that 65%-70% of the fraud losses were attributable to challenged bankruptcies and 30% were attributable to first payment defaults. CW1 stated that neither CW1 nor the OCC agreed with this classification and that Hashman and Cai participated in several meetings with the OCC. CW7 stated that a former NextCard fraud manager stated that the Company's treatment of fraud losses was inappropriate and not in line with industry standards. CW7 also stated that the former fraud manager left the Company shortly after voicing his opinions to defendant Cai. These witness accounts confirm the OCC findings.
63. CW1 stated that NextCard classified challenged bankruptcies as credit losses until 2Q01 when Hashman and Cai decided to classify them as fraud losses. CW1 stated that practice was not consistent with the rest of the industry and that CW1 and the OCC disagreed with it. CW1 stated that the practice was improper and that anyone who says otherwise is lying. CW1 also stated that by removing delinquent loans classified as "challenged bankruptcies" from the pool of loans used to calculate loan loss allowances the Company's loan loss provisions and loan reserves declined significantly. It also reduced the level of reported delinquent loans because the Company wrote-off the loans (as opposed to establishing a reserve) classified as fraud losses.
64. By improperly classifying loan loss allowances as fraud losses, defendants caused the Company to report that its net interest margin (after loan loss provisions), a key indicator of financial performance and credit quality, was higher than it actually was. As shown below, the Company's net interest margin was deteriorating. It was important for the Company to mitigate the deterioration and to report a higher net interest margin to address the concerns analysts raised about the Company's credit quality prior to and throughout the Class Period. The following table illustrates how the Company's loan loss provisions and net interest margin were understated throughout the Class Period.(1)
3/00 6/00 9/00 12/00
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Net Interest Income $9,165 $9,721 $12,595 $12,741
LLA Provision $8,600 $9,563 $16,134 $22,843
Net Interest Margin $565 $158 ($3,359) ($10,102)
Fraud Loss Provision $1,487* $2,206* $4,101* $3,821*
3/01 6/01 9/01
Net Int. Income $6,910 $7,158 $11,292
LLA Provision $20,049 $18,509 $55,534
Net Interest Margin ($13,139) ($11,351) ($44,242)
Fraud Loss Provision $2,370 $2,692 $1,496
* estimate
65. The magnitude of the increase in loan loss allowances by the end of and after the Class Period also confirms that the loan losses were materially understated during the Class Period and that defendants knew it. The Company incurred a $55.5 million expense in 3Q01 and increased loan loss allowances from $31.1 million as of 6/30/01 to $71.6 million as of 9/30/01.
66. The failure to establish adequate loan loss allowances violated GAAP (SFAS 5), SEC regulations (17 C.F.R. §210.4-01(a)(1)) and federal banking regulations (12 C.F.R. Part 3).
B. Defendants Caused NextBank to Report Inflated Earnings and Capital by Improperly Capitalizing Credit Card Acquisition Costs
67. NextCard spent money on advertising to attract credit card customers and recorded the cost as sales and marketing expenses as required by GAAP. NextBank actually made the credit card loans after NextCard acquired a customer and sold the account to NextBank for the cost of the acquisition. Although NextCard expensed the card acquisition costs, defendants caused NextBank to improperly capitalize the acquisition costs. The improper capitalization caused NextBank to overstate earnings and capital by $35.7 million.
68. The Company's write-off of the capitalized acquisition costs after the Class Period confirms the impropriety. On 10/31/01, NextBank announced that it had expensed $35.7 million of improperly capitalized card acquisition costs.
69. The material amounts of card acquisition costs that were improperly capitalized violated GAAP, SEC and banking regulations and the Company's financial policies. Specifically, NextBank understated earnings, capital and regulatory capital by improperly capitalizing the card acquisition costs.
70. As the write-off of the capitalized acquisition costs confirms, there was no reasonable basis for
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NextBank to capitalize the card acquisition costs that NextCard expensed. The sole motivation for the improper capitalization was to avoid paying NextBank additional funds required to maintain its risk-based capital at levels required by the undisclosed 10/26/00 capital assurance agreement. Deutsche Banc analyst Zandi recognized the scam. In a report issued on 11/1/01 he summed it up as follows:
Every time that we have met with management or have seen them present to investors, they went to great pains to insist that the company was operated on a conservative basis. High credit quality and conservative accounting. After all, so they argued, NextCard was regulated so their accounting had to be conservative. There is no scenario we can imagine in which capitalizing acquisition costs at NextBank can be viewed as conservative accounting. Very damning in our opinion.
C. Defendants Caused the Company to Report Inflated Regulatory Capital Ratios by Improperly Excluding Sold Loans from Risk Weighted Assets
71. Defendants also caused NextBank to materially understate its risk-based capital requirement by failing to include sold loans in risk weighted assets. NextCard falsely represented in its SEC filings that investors in the Company's securitization transactions had "no recourse" against the Company for any customers' failure to pay their credit card loans. See, e.g., Note 8 to NextCard's audited F00 financial statements contained in the Company's SEC Form 10-K. Under federal banking regulations, only loans sold without recourse could be excluded from NextBank's risk weighted assets. Per the undisclosed capital assurance agreement, the OCC required NextCard to maintain NextBank's risk-based capital at 12% of risk weighted assets. As shown in the following table, NextBank's risk-based capital requirement would have increased substantially if sold loans were included in risk weighted assets (in millions).
3/31/00 6/30/00 9/30/00 12/31/00
Securitized Loans Not Included in RWA $300 $300 $520 $762.5
Corresponding Reduction In Risk-Based Capital $36 $36 $62.4 $91.5
3/31/01 6/30/01 9/30/01
Securitized Loans Not Included in RWA $1,115 $1,200 $1,264
Corresponding Reduction In Risk-Based Capital $133.8 $144 $151.7
72. In fact, contrary to the representation in the Company's SEC filings, investors did have recourse against NextCard for customers' failure to pay. As explained in a 2/7/02 OCC press release, during its 2001 examination of NextBank, the OCC determined that NextBank was repurchasing delinquent loans sold into a securitization trust that it classified as fraud losses even though the delinquencies were attributable to credit quality problems. The OCC and CW1 stated that the Company's classification of certain loan losses as fraud losses was improper and inconsistent with industry standards. According to the OCC, that practice constituted a sale of assets with recourse that required all the sold loans to be included in risk weighted assets. The Company disputed and appealed the OCC's findings. That appeal was rejected by the
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OCC on 10/29/01.
73. When the loans were properly included in risk weighted assets, total risk weighted assets increased by more than $1 billion from $1.08 billion as of 6/30/01 to $2.1 billion as of 9/30/01. That increase alone caused NextBank's risk-based capital requirement to rise by more than $120 million. A 2/12/02 New York Times article reported that the impropriety was reminiscent of the problems at Enron.
D. Defendants Made False and Misleading Statements About the Number of Customer Accounts
74. As set forth in ¶38, throughout the Class Period, the Company reported increasing numbers of customer accounts. In fact, NextCard reported an increase in accounts in every quarterly earnings release and issued a separate press release on 6/26/01 announcing the Company had exceeded one million customers. Witnesses have informed plaintiffs that the number of customer accounts reported by the Company was misleading. CW5 and CW6, a former NextCard operations manager, stated that NextCard purposely failed to close accounts despite customers requesting that their accounts be closed. CW6 stated this was done to increase the number of reportable accounts and that the practice deceived shareholders into thinking there were more open accounts on the books. CW6 said the practice was particularly followed as the Company was trying to reach a milestone of one million accounts (which the Company first reported on 6/26/01). According to CW5, customers asked for their accounts to be closed because NextCard was increasing fees and APRs on their credit cards. CW8, a former NextCard collections representative, also stated that customers complained about increases in credit card interest rates that were not always supported by the documentation containing the terms and conditions for the customer's account. When CW8 questioned the fairness and legality of the practice, CW8 was told to just do CW8's job and not to worry about it.
FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD
A. Defendants' False and Misleading Statements Regarding NextCard's 1Q00 Results
75. False Statement: On 4/19/00, NextCard issued a press release announcing "extremely strong results" in the first quarter ended 3/31/00. The press release stated in part:
NextCard, Inc., the leading issuer of consumer credit on the Internet, today announced extremely strong results for the first quarter ended March 31, 2000.
* * *
Total managed loans as of March 31, 2000 rose 53 percent to $638.8 million, compared with $416.3 million in managed loans as of December 31, 1999, and rose 563 percent over the $96.3 million in managed loans as of March 31, 1999. Total customer accounts as of March 31, 2000 increased 53 percent to approximately 337,000, from approximately 220,000 as of December 31, 1999.
"This quarter has been another outstanding achievement for us, maintaining our excellent track record of consistent positive news on growth in balances, customers, revenues and the key economic drivers of the business," said Jeremy Lent, Chairman and CEO of NextCard. "With our Internet-based profiling and customization capabilities, NextCard is continuing to build the foundation of a highly profitable business at a dramatic growth rate."
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"NextCard's continued success," added Lent, "is based in both our solid execution and our strategic positioning. The credit card business has long been established as one that thrives on direct marketing, and the Internet is the ultimate direct marketing channel. NextCard has used the power of the Internet to reinvent the credit card product and build an industry leading position in technology and online marketing. Our first quarter results and expectations to originate one billion dollars in new loans this year demonstrate that our historic market opportunity continues to increase."
NextCard reported a first quarter net loss of $17.7 million, or a net loss per share of $0.34, which is six cents better than the First Call consensus net loss estimate of $0.40. This compares to a net loss price per share of $0.53 in the fourth quarter and a $0.30 pro forma net loss per share in the first quarter of 1999.
Managed net interest margin for the loan portfolio was 5.89 percent in the first quarter of 2000, up from 5.50 percent in the fourth quarter 1999.
76. False Statement: The Company's 1Q00 results were repeated to the market in reports issued by Prudential Securities analyst Jennifer S. Scutti and CIBC analyst Daniel on 4/20/00. The Company's 1Q00 financial results were also repeated to the market in the Company's SEC Form 10-Q that was signed by defendants Lent and Hashman.
77. Defendants' Knowledge of and Reasons Why the Statements Regarding the Company's 1Q00 Results Were Materially False and Misleading: The statements contained in the press release, analysts' reports and SEC Form 10-Q were materially false and misleading for the reasons set forth in ¶¶51-74. Additionally,
(a) defendants knew that the Company's 1Q00 financial results were not "extremely strong" as represented in the 4/19/00 press release or prepared in accordance with GAAP as represented in the 5/15/00 SEC Form 10-Q. In fact, the $17.7 million net loss was inflated due to the Company's failure to establish sufficient loan loss allowances on its credit card loans that were deteriorating in credit quality. In her 4/20/00 report, Prudential Securities analyst Scutti remained "cautious and critical" about credit quality given the "rising delinquency trend on all fronts." CIBC analyst Daniel reported it was "too early to tell" whether management could overcome the inherent risk of generating accounts over the Internet;
(b) defendants knew NextCard's net interest income after provision for loan losses was not $565,000 as reported in the 4/19/00 press release and 10-Q because NextCard did not establish sufficient loan loss allowances and because the Company improperly classified certain loan loss allowances as "fraud losses" and buried the fraud loss expense in "other non-interest expense";
(c) defendants knew the statement that total customer accounts numbered 337,000 as of 3/31/00 was false and misleading because that number included accounts that customers had asked to be closed;
(d) at 3/31/00 NextBank reported risk based capital of $82.075 million, risk weighted assets of $696.3 million and a risk based capital ratio of 11.79%. Defendants knew risk based capital was overstated because of the failure to establish sufficient loan loss allowances and the improper capitalization of credit card acquisition costs. Defendants knew risk weighted assets were understated by $300 million because NextBank improperly excluded $300 million of loans sold that did not qualify for low level recourse treatment. As reported by the OCC, they did not qualify for low level recourse treatment because the Company was buying back certain loans;
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(e) based on the foregoing, defendants knew that Lent's statement in the 4/19/00 press release that "NextCard is continuing to build the foundation of a highly profitable business and at a dramatic growth rate" was false and misleading. Defendants also knew that NextCard's purported "continued success" was not "based in both our solid execution and our strategic positioning," but was an illusion caused by defendants' fraud.
B. Defendant Lent Made False and Misleading Statements at the 6/26/00 UBS Warburg Global Financial Services Conference
78. False Statement: On 6/27/00, UBS Warburg analyst Diane B. Glossman issued a report based on and repeating statements made by defendant Lent on 6/26/00 during a presentation made at UBS Warburg's Global Financial Services Conference. According to Glossman, Lent's presentation focused on NextCard's strategy at combining technological innovation with target marketing that was designed to seek high quality credit card customers on the Web. Glossman reported that during his presentation Lent represented that NextCard used "data-mining and other technologies to selectively target a strong credit demographic on the Web." Lent also represented that NextCard's "margin remains healthy at 5.9%." Lent also reiterated that NextCard would "break-even in early 2002 * * * without raising additional capital."
79. Lent Knew His Statements Were False and Misleading: Lent knew that the statements he made at the 6/26/00 UBS Warburg Financial Services Conference were false and misleading. Specifically, Lent knew that NextCard had lowered required FICO scores to increase application approval rates, lower acquisition costs and increase growth. He also knew that the lowering of FICO scores targeted a weaker credit demographic on the web and was resulting in deteriorating credit quality. His reiteration that NextCard would breakeven in early 2002 without raising additional capital was false and misleading because he knew that NextCard's ability to attain profitability was dependant on the continuation of defendants' fraud.
C. Defendants' False and Misleading Statements Regarding NextCard's 2Q00 Results
80. False Statement: On 7/27/00, the Company issued a press release announcing "extremely strong results for the second quarter" that beat First Call consensus estimates. The press release stated in part:
NextCard, Inc. (NASDAQ:NXCD)(www.NextCard.com) today announced extremely strong results for the second quarter.
* * *
Total managed loans as of June 30, 2000 rose 408 percent to $829.7 million, compared to $163.4 million as of June 30, 1999, and rose 30 percent to over $638.8 million in managed loans as of March 31, 2000. Total customer accounts as of June 30, 2000 increased 421 percent to 443,000, compared to approximately 85,000 customer accounts as of June 30, 1999, and increased 31 percent over the approximately 337,000 customer accounts as of March 31, 2000.
NextCard reported a second quarter net loss of $24.5 million, or a net loss per share of $0.46, beating First Call consensus estimates for the fifth consecutive quarter as a public company. This compares to a $0.45 pro forma net loss per share for the same period in 1999 and a net loss per share of $0.50 prior to a one-time gain for the quarter ended March 31, 2000. The net loss per share in the first quarter included a one-time gain of $8.3 million, or $0.16 per share, from the Company's $300.0 million off-balance sheet securitization completed in the first quarter 2000.
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* * *
"We demonstrated another excellent quarter of consistent execution across all areas of our business," said Jeremy Lent, Chairman and CEO. "The key economic drivers of our business model continue to progress ahead of schedule. With a higher than expected yield and strong growth at a favorable acquisition cost, our business fundamentals drove another outstanding quarter for the Company."
"NextCard has used the power of the Internet to reinvent the credit card product and build an industry leading position in technology and online marketing," continued Lent. "Given the strength of our business model, and our consistent execution and performance, we are bringing in the break-even date for the Company once again. We now expect to achieve profitability by late 2001, a full year earlier than the break-even date anticipated when NextCard went public last spring."
The net charge-off rate for managed loans increased to 2.2 percent for the second quarter 2000, compared to 1.9 percent in the first quarter 2000. The delinquency rate (30+ days) on total managed loans increased 2.7 percent as of June 30, 2000, compared to 1.7 percent as of March 31, 2000. The delinquency and charge-off rates are in-line with the Company's expectations given the natural seasoning of the loan portfolio over time.
NextCard continues to build strength on its balance sheet and maintains a very strong cash position. The allowance for loan losses as a percentage of on-balance sheet loans increased to 3.2 percent as of June 30, 2000, compared to 3.0 percent as of March 31, 2000. The increase in the allowance reflects the Company's conservative approach to loan reserves.
81. False Statement: The Company's 2Q00 results were repeated in analysts' reports issued by CIBC analyst Daniel, Prudential Securities analyst Scutti, First Union analyst Whitney and WR Hambrecht & Co. ("Hambrecht") analyst Jonathon Fayman on 7/28/00. The 2Q00 results were also repeated in the Company's SEC Form 10-Q issued on 8/15/00 and signed by defendants Hashman and Rigione.
82. Defendants' Knowledge of and Reasons Why the Statements Regarding the Company's 2Q00 Results Were Materially False and Misleading: The statements contained in the press release, analysts' reports and SEC Form 10-Q were materially false and misleading for the reasons set forth in ¶77. Additionally,
(a) defendants knew that NextCard's 2Q00 results were not "extremely strong" and that the reported 2Q01 net loss of $24.5 million was false and misleading because the Company was not establishing sufficient loan loss allowances. Thus, the statement that "the increase in the allowance reflects the Company's conservative approach to loan reserves" was also known to be false. The OCC confirmed after the Class Period that the Company had not established sufficient loan reserves and analysts reported that defendants had misled when they represented the Company was operated on a conservative basis;
(b) defendants knew that NextCard's net interest income after provision for loan losses was not $392,000 as reported in the 7/27/00 press release or $158,000 as reported in the SEC Form 10-Q because NextCard did not establish sufficient loan loss allowances and because the Company improperly classified certain loan loss allowances as "fraud losses" and buried the fraud loss expense in "other non-interest expense";
(c) defendants knew the statement that total customer accounts numbered 443,000 as of 6/30/00
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was false and misleading because that number included accounts that customers had asked to be closed;
(d) in its SEC Form 10-Q and Call Report for 2Q00, NextBank reported risk based capital of $109.9 million, risk weighted assets of $897 million and a risk based capital ratio of 12.26%. Defendants knew risk based capital was overstated because of the failure to establish sufficient loan loss allowances and the improper capitalization of credit card acquisition costs. Defendants knew risk weighted assets were understated by $300 million because NextBank improperly excluded $300 million of loans sold that did not qualify for low level recourse treatment. They did not qualify for low level recourse treatment because the Company was buying back certain loans;
(e) for the foregoing reasons, Lent's other positive statements regarding the strength of the Company's business model and management's consistent execution and performance were also false and misleading. In fact, as investors would discover after the Class Period, the Company's business model (i.e., solely originating credit card loans over the Internet) was a failure that resulted in the OCC placing NextBank into receivership.
D. The False and Misleading Statements Made in the 9/11/00 Press Release and Analyst Reports
83. False Statement: On 9/11/00, NextCard issued a press release announcing the Company had exceeded $1 billion in loans outstanding from its credit card customers, and surpassed 500,000 customer accounts. Hashman was quoted in the press release as stating that (a) "NextCard's achievement of these milestones is further validation that our business model for credit card issuance on the Internet is clearly working," and (b) "NextCard continues to apply stringent credit and risk management standards to our portfolio as we close in on our profitability target of Q4 2001."
84. False Statement: On 9/11/00, Hambrecht analyst Fayman issued a report based on and repeating statements made by defendants Hashman and Rigione at WR Hambrecht headquarters in San Francisco on 9/6/00. Rigione and Hashman represented, among other things that "credit quality is well under control."
85. Defendants' Knowledge of and Reasons Why the Statements Contained in the 9/11/00 Press Release and Analyst Report Were Materially False and Misleading: The statements contained in the press release and analyst report were materially false and misleading for the reasons set forth in ¶82. In addition,
(a) defendants knew the OCC had completed its first annual examination of NextBank in 9/00. During that examination, the OCC concluded that NextBank had failed to identify the extent of its credit quality problems, the bank's assets were of lower credit quality than initially projected in the bank's business plan and the bank's risk management policies and procedures were inadequate. The OCC's adverse examination findings were not disclosed and directly contradicted the defendants' statements that "credit quality [was] well under control" and that the Company was applying "stringent credit and risk management standards" to its portfolio;
(b) in fact, due to the adverse examination findings the OCC insisted that NextCard and NextBank execute a capital assurance agreement whereby NextCard guaranteed that NextBanks's regulatory capital would be at least 12% of risk weighted assets, 50% more than the 8% required by federal banking regulations. The capital assurance agreement was executed on 10/26/00 but was not publicly disclosed until after the Class Period.
E. Defendants' False and Misleading Statements Regarding NextCard's 3Q00 Results
86. False Statement: On 10/19/00, just seven days before NextCard and NextBank executed the capital
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assurance agreement at the insistence of the OCC, the Company issued another bullish press release announcing it expected to report 3Q00 revenues of $55 million, considerably higher than consensus analyst expectations. Defendant Hashman was quoted in the press release as stating, "With the rising number of disappointing earnings pre-announcements this quarter, we want to reiterate that the key economic drivers of our business continue to progress ahead of schedule and that we are building the platform for a very profitable business." The statements contained in the 10/19/00 press release were repeated to the market in a report issued by Hambrecht analyst Fayman on 10/23/00.
87. False Statement: On10/25/00, the day before the capital assurance agreement was executed, the Company issued another bullish press release announcing "extremely strong results." The press release stated in part:
NextCard, Inc. (NASDAQ: NXCD; www.NextCard.com) today announced extremely strong results for the third quarter of 2000.
Total managed loans rose 308 percent to $1.093 billion as of September 30, 2000, compared to $268.0 million as of September 30, 1999, and rose 32 percent over the $829.7 million in managed loans as of June 30, 2000. Total customer accounts increased 331 percent to 577,000 as of September 30, 2000, compared to approximately 134,000 customer accounts as of September 30, 1999, and increased 30 percent over the approximately 443,000 customer accounts as of June 30, 2000.
NextCard reported a third quarter net loss of $20.3 million, or a net loss per share of $0.38, beating First Call consensus estimates for the sixth consecutive quarter as a public company. Excluding a $1.8 million investment to develop the U.K. technology an operations platform, NextCard's net loss was $18.5 million, or $0.35 per share, four cents better than consensus estimates. This compares to a $0.50 net loss per share for the same period in 1999 and a net loss per share of $0.46 for the quarter ended June 30, 2000.
Total yield on the managed loan portfolio for the third quarter 2000 increased to 19.0 percent from 15.9 percent in the second quarter of 2000. Risk adjusted margin on the managed loan portfolio for the third quarter 2000 increased to 9.1 percent from 6.8 percent in the second quarter of 2000. The strong increases in yield and risk adjusted margin were driven by NextCard's marketing of fee-based products and a general increase in its fee structure in conjunction with locating NextBank's domicile in Arizona. In addition, the increases were attributed to NextCard's ability to uniquely customize each customers' offer in real time through the Company's proprietary Profile Based Pricing technology.
"We demonstrated another excellent quarter of consistent execution across all areas of our business," said John Hashman, President and CEO. "The key economic drivers of our business model continue to progress ahead of schedule. We are especially satisfied with the growth in revenues and the yield in our portfolio. Our revenue yield was 19 percent for the third quarter reflecting success in our Profile Based Pricing and new fee initiatives, and it is further evidence that we are building the platform for a profitable business."
* * *
Hashman continued, "We have made great progress in building the foundation for our U.K. business, which is consistent with our strategy for the year 2000. We continue to believe the U.K. market represents a huge opportunity for online credit card lending. Internet usage is increasing and the dynamics of the U.K. credit card market are extremely favorable. We
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believe NextCard can become a dominant online consumer credit brand in the U.K., as it has for the U.S."
The net charge-off rate for managed loans increased to 2.7 percent for the third quarter 2000, compared to 2.2 percent in the second quarter 2000. The delinquency rate (30+ days) on total managed loans increased to 3.3 percent as of September 30, 2000, compared with 2.7 percent as of June 30, 2000. The delinquency and charge-off rates are in-line with the Company's expectations given the natural seasoning of the loan portfolio.
NextCard continues to build strength on its balance sheet and maintains a very strong cash position. The allowance for loan losses as a percentage of on-balance sheet loans increased to 3.9 percent as of September 30, 2000, compared to 3.2 percent as of June 30, 2000. The increase in the allowance reflects the Company's conservative approach to loan reserves.
88. False Statement: The statements contained in the 10/25/00 press release were repeated to the market in analysts reports issued on 10/26/00 by CIBC analyst Daniel, Hambrecht analyst Fayman, Prudential Securities analyst Scutti and First Union analyst Whitney. The statements were also repeated to the market in the SEC Form 10-Q issued on 11/14/00 signed by defendants Hashman and Rigione.
89. Defendants' Knowledge of and Reasons Why the Statements Regarding the Company's 3Q00 Results Were Materially False and Misleading: The statements contained in the press releases, analysts' reports and SEC Form 10-Q were materially false and misleading for the reasons set forth in ¶85. Additionally,
(a) defendants knew that NextCard's 3Q00 results were not "extremely strong" and that the reported 3Q00 net loss of $20.3 million was false and misleading because the Company was not establishing sufficient loan loss allowances. Thus, the statement that "the increase in the allowance reflects the Company's conservative approach to loan reserves" was also known to be false. The OCC had just completed its first annual examination in 9/00 and made numerous adverse examination findings. As a result, the OCC insisted that NextCard maintain NextBank's regulatory capital at 12% of risk weighted assets, 50% more than required by law. The capital assurance agreement insisted upon by the OCC was executed by NextCard and NextBank (and signed by Hashman) on 10/26/00, the day after the defendants caused NextCard to issue the 10/25/00 press release. The fact that NextCard was not establishing sufficient loan reserves was confirmed after the Class Period when the Company more than doubled its loan loss allowances after a subsequent OCC examination. Analysts also reported that defendants had misled when they represented the Company was operated on a conservative basis;
(b) defendants knew that NextCard's net interest income after provision for loan losses was not ($3.5) million as reported in the 10/25/00 press release and SEC Form 10-Q because NextCard did not establish sufficient loan loss allowances and because the Company improperly classified certain loan loss allowances as "fraud losses" and buried the fraud loss expense in "other non-interest expense";
(c) defendants knew the statement that total customer accounts numbered 577,000 as of 9/30/00 was false and misleading because that number included accounts that customers had asked to be closed;
(d) in its SEC Form 10-Q and Call Report for 3Q00, NextBank reported risk based capital of $135.5 million, risk weighted assets of $1.2 billion and a risk based capital ratio of 11.37%. Defendants knew risk based capital was overstated because of the failure to establish sufficient loan loss allowances and the improper capitalization of credit card acquisition costs. Defendants knew risk weighted assets were understated by $520 million because NextBank improperly excluded $520 million of loans sold that did not qualify for low level recourse treatment. They did not qualify for low level recourse treatment because
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the Company was buying back certain loans;
(e) for the foregoing reasons, Hashman's other positive statements regarding the strength of the Company's business model and management's consistent execution were also false and misleading. In fact, as investors would discover after the Class Period, the Company's business model (i.e., solely originating credit card loans over the Internet) was a failure that resulted in the OCC placing NextBank into receivership.
F. The False and Misleading 11/2/00 Press Release Regarding the Company's First Annual Investor Day
90. False Statement: On 11/2/00 the Company issued another bullish press release announcing it had held its first annual Investor Day during which the Company increased 2002 earnings guidance 50% to $75 million and initiated 2003 earnings guidance of $150 million. Hashman was quoted in the press release as stating that NextCard expected to reach profitability by the end of 2001, a full year earlier than projected in the Company's original plan.
91. False Statement: On 11/2/00 CIBC analyst Daniel, Hambrecht analyst Fayman and Prudential Securities analyst Scutti issued reports based on and repeating statements made by defendants during the Company's Investor Day.
92. Stock Price Increases 33%: In response to the Company's substantial increase in earnings guidance for 2002, the Company's stock price increased 33% to $10.69 per share.
93. Defendants' Knowledge of and Reasons Why the Statements Contained in the 11/2/00 Press Release and Analyst Reports Were Materially False and Misleading: The statements contained in the press release and analyst reports were materially false and misleading for the reasons set forth in ¶89.
G. Defendants' False and Misleading Statements Regarding NextCard's 4Q00 and F00 Results
94. False Statement: On 12/19/00, NextCard issued a press release reaffirming 4Q00 and F01 revenue guidance of $68 million and $370 million, respectively. Hashman was quoted in the press release as stating, "Our business model continues to outperform, with strong consumer demand and an increasing yield combining to drive revenue growth. We expect the favorable trend in business performance and revenues to continue into 2001 and beyond, and we remain extremely confident about our previously published guidance. The continued strong growth in the Internet channel and our proven execution only increases confidence in our ability to meet our ambitious growth targets as we move toward profitability. The outlook for NextCard grows stronger with each quarter."
95. False Statement: On 1/24/01 the Company issued another bullish press release announcing "extremely strong results" for 4Q00. The press release stated in part:
NextCard, Inc. (NASDAQ: NXCD; www.NextCard.com) today announced extremely strong results for the fourth quarter of 2000.
* * *
Total managed loans 215 percent to $1.312 billion as of December 31, 2000, compared to $416.3 million as of December 31, 1999, and rose 20 percent over the $1.093 billion in managed loans as of September 30, 2000. Total customer accounts increased 222 percent to
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708,000 as of December 31, 2000, compared to approximately 220,000 customer accounts as of December 31, 1999, and increased 23 percent over the approximately 577,000 customer accounts as of September 30, 2000.
NextCard reported a fourth quarter net loss of $19.4 million, or a net loss per share of $0.37, beating First Call consensus estimates for the seventh consecutive quarter as a public company. This compares to a net loss per share of $0.53 in the fourth quarter of 1999 and a net loss per share of $0.38 in the third quarter of 2000.
Total yield on the managed loan portfolio for the fourth quarter 2000 increased to 19.6 percent from 19.0 percent in the third quarter of 2000. Risk adjusted margin on the managed loan portfolio for the fourth quarter 2000 increased to 9.4 percent from 9.1 percent in the third quarter of 2000. The strong increases in yield and risk adjusted margin were driven by NextCard's marketing of fee-based products and its ability to customize each customer's offer through the Company's proprietary Profile Based Pricing technology.
"Our fourth quarter results demonstrate that we are consistently scaling the business ahead of expectations, and we are on-track to achieve profitability by the end of the year," said John Hashman, President and CEO. "We continue to see increasingly strong demand for our core product. The key drivers of our business, including our risk-adjustment margin and acquisition cost per account, have never been better."
"We originated over a billion dollars in new loans through the Internet during 2000, solidifying our leadership position in the fastest growing channel of the credit card market," continued Hashman. "Our ability to grow rapidly and efficiently is a testament to both our industry leading technology platform and our strong execution. As pioneers in technology-based-lending, we look forward to providing real-time, customized products and services to millions of new customers over the next few years."
The net charge-off rate for managed loans increased to 3.1 percent for the fourth quarter of 2000, compared to 2.7 percent in the third quarter 2000. The delinquency rate (30+ days) on total managed loans increased to 3.9 percent as of December 31, 2000, compared with 3.3 percent as of September 30, 2000. The delinquency and charge-off rates are in-line with the Company's expectations given the natural seasoning of the loan portfolio.
* * *
NextCard continues to build strength on its balance sheet and maintains a very strong cash position. The allowance for loan losses as a percentage of on-balance sheet loans increased to 4.8 percent as of December 31, 2000, compares to 3.9 percent as of September 30, 2000.
96. False Statement: The statements made in the press release were repeated in a report issued by Prudential Securities analyst Scutti on 1/24/01 and in the Company's SEC Form 10-K issued on 3/30/01 and signed by defendants Hashman, Lent, Rigione and Qureshey.
97. Defendants' Knowledge of and Reasons Why the Statements Regarding the Company's 4Q00 and F00 Results Were Materially False and Misleading: The statements contained in the press releases, analysts' reports and SEC Form 10-K were materially false and misleading for the reasons set forth in ¶93. Additionally,
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(a) defendants knew that NextCard's 4Q00 results were not "extremely strong" and that the reported 4Q00 net loss of $19.4 million was false and misleading because the Company was not establishing sufficient loan loss allowances. Defendants continued to conceal the OCC's adverse examination findings and the 10/26/00 capital assurance agreement. The fact that NextCard was not establishing sufficient loan reserves was confirmed after the Class Period when the Company more than doubled its loan loss allowances after a subsequent OCC examination. Analysts also reported that defendants had misled when they represented the Company was operated on a conservative basis;
(b) defendants knew that NextCard's net interest income after provision for loan losses was not ($10.1) million as reported in the 1/24/01 press release because NextCard did not establish sufficient loan loss allowances and because the Company improperly classified certain loan loss allowances as "fraud losses" and buried the fraud loss expense in "other non-interest expense";
(c) defendants knew the statement that total customer accounts numbered 708,000 as of 12/31/00 was false and misleading because that number included accounts that customers had asked to be closed;
(d) in its SEC Form 10-K and Call Report for 4Q00, NextBank reported risk based capital of $187 million, risk weighted assets of $1.2 billion and a risk based capital ratio of 15.73%. Defendants knew risk based capital was overstated because of the failure to establish sufficient loan loss allowances and the improper capitalization of credit card acquisition costs. Defendants knew risk weighted assets were understated by $762 million because NextBank improperly excluded $762 million of loans sold that did not qualify for low level recourse treatment. They did not qualify for low level recourse treatment because the Company was buying back certain loans;
(e) for the foregoing reasons, Hashman's other positive statements including that the Company was "on track" to achieve profitability by the end of 2001, the Company's 4Q00 results demonstrated NextCard was consistently scaling the business ahead of expectations, the origination of over $1 billion of loans solidified the Company's leadership position and the ability to grow rapidly and efficiently was a testament to the Company's industry leading technology platform and strong execution were also false and misleading. In fact, as investors would discover after the Class Period, the Company's business model (i.e., solely originating credit card loans over the Internet) was a failure that resulted in the OCC placing NextBank into receivership.
H. Defendants' False and Misleading Statements Regarding NextCard's 1Q01 Results
98. False Statement: On 4/25/01, the Company issued another bullish press release announcing "strong results" for 1Q01. The press release stated in part:
NextCard, Inc. today announced strong results for the first quarter of 2001. Total managed revenue, which includes the impact of securitization activities, increased to $81.7 million. Operating revenue on a managed basis increased to $70.5 million for the quarter ended March 31, 2001, compared to $22.7 million for the quarter ended March 31, 2000, and $62.0 million for the quarter ended December 31, 2000. This represents an increase of 210 percent over the same period in 2000 and an increase of 14 percent over the previous quarter.
Total managed loans rose 150 percent to $1.595 billion as of March 31, 2001, compared to $638.8 million as of March 31, 2000, and rose 22 percent over the $1.312 billion in managed loans as of December 31, 2000. Total customer accounts increased over 160 percent to 881,000 as of March 31, 2001, compared to approximately 708,000 customer accounts as of December 31, 2000.
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NextCard reported a first quarter net loss of $16.6 million, or a net loss per share of $0.31, beating First Call consensus estimates for the eighth consecutive quarter as a public company. This compares to a net loss per share of $0.34 in the first quarter of 2000 and a net loss per share of $0.37 in the fourth quarter of 2000.
"Our first quarter results show improvement in the key metrics and demonstrate that we are on track to meet our goal of reaching profitability by the end of this year," said John Hashman, Chief Executive Officer. "We continue to see increasingly strong demand for our core product. Our acquisition cost per account reached another record low, and our net interest and risk-adjusted margins remain strong."
"Our ability to grow rapidly and efficiently can be attributed to our industry-leading technology platform and our strong execution. As leaders in technology-based lending, we look forward to providing more exciting customized products and services to both new and existing customers," continued Hashman.
* * *
The net charge-off rate for managed loans increased to 3.99 percent for the first quarter 2001, compared to 3.10 percent in the fourth quarter 2000. The delinquency rate (30+ days) on total managed loans increased to 4.75 percent as of March 31, 2001, compared with 3.92 percent as of December 31, 2000. The delinquency and charge-off rates are in-line with the Company's expectations given the natural seasoning of the loan portfolio.
"We have seen positive results from the implementation of our next generation risk scorecard which utilizes more conservative underwriting standards," said Yinzi Cai, President and Chief Operating Officer. "The results from our new scorecard, in conjunction with increased productivity in our collections operations, leads us to believe that delinquencies should increase at a slower rate in the second quarter compared to recent quarters."
NextCard continues to build strength on its balance sheet and maintains a very strong cash position. The allowance for loan losses as a percentage of on-balance sheet loans increased to 5.08 percent as of March 31, 2001, compared to 4.76 percent as of December 31, 2000. Consolidated cash and liquid investments were $215.7 million as of March 31, 2001.
* * *
NextCard completed the sale of the $17.5 million subordinated Class D notes that had been retained by the company in its December 2000 term securitization. The sale of the Class D notes qualify the entire $500 million term securitization for "low-level capital recourse" treatment under bank regulatory capital guidelines. The $17.5 million Class D notes were rated Ba2 and BB (Moody's, S&P) and were privately placed under Rule 144A. With the sale of the Class D notes completed, NextCard has achieved its target level of capital efficiency for the term securitization program. This, along with other diversified funding sources, keeps the Company well on track to meet its growth targets without raising additional equity capital.
99. False Statement: The statements made in the 4/25/01 press release were repeated to the market in reports issued by First Union analyst Whitney and Duetsche Banc analyst Zandi on 4/26/01. The
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statements were also repeated to the market in the Company's SEC Form 10-Q issued on 5/15/01 and signed by defendant Rigione.
100. Defendants' Knowledge of and Reasons Why the Statements Regarding the Company's 1Q01 Results Were Materially False and Misleading: The statements contained in the press releases, analysts' reports and SEC Form 10-Q were materially false and misleading for the reasons set forth in ¶97. Additionally,
(a) defendants knew that NextCard's 1Q01 results were not "strong" and that the reported 1Q01 net loss of $16.6 million was false and misleading because the Company was not establishing sufficient loan loss allowances. Defendants continued to conceal the OCC's adverse examination findings and the 10/26/00 capital assurance agreement. The fact that NextCard was not establishing sufficient loan reserves was confirmed after the Class Period when the Company more than doubled its loan loss allowances after a subsequent OCC examination. Analysts also reported that defendants had misled when they represented the Company was operated on a conservative basis;
(b) defendants knew that NextCard's net interest income after provision for loan losses was not ($13.1) million as reported in the 4/25/01 press release and SEC Form 10-Q because NextCard did not establish sufficient loan loss allowances and because the Company improperly classified certain loan loss allowances as "fraud losses" and buried the fraud loss expense in "other non-interest expense." Indeed, according to CW1, it was during 2Q01 that Hashman and Cai decided to improperly classify losses on "challenged bankruptcies" as fraud losses;
(c) defendants knew the statement that total customer accounts numbered 881,000 as of 3/31/01 was false and misleading because that number included accounts that customers had asked to be closed;
(d) in its SEC Form 10-Q and Call Report for 1Q01, NextBank reported risk based capital of $188 million, risk weighted assets of $1.5 billion and a risk based capital ratio of 12.6%. Defendants knew risk based capital was overstated because of the failure to establish sufficient loan loss allowances and the improper capitalization of credit card acquisition costs. Defendants knew risk weighted assets were understated by $1.2 billion because NextBank improperly excluded $1.2 billion of loans sold that did not qualify for low level recourse treatment. They did not qualify for low level recourse treatment because the Company was buying back certain loans;
(e) Cai's statement that the Company was "utiliz[ing] more conservative underwriting standards" was known to be false. As set forth in ¶¶52-55, witnesses and the OCC stated that NextCard had considerably loosened underwriting criteria and lowered FICO scores to increase growth;
(f) the statement that the $500 million term securitization qualified for low level capital recourse treatment under bank regulatory capital guidelines was known to be false because NextCard was improperly classifying credit losses as fraud losses and repurchasing the loans;
(g) For the foregoing reasons, Hashman's other positive statements including that the Company was "on track" to achieve profitability by the end of 2001, the Company's 1Q01 results demonstrated NextCard was consistently scaling the business ahead of expectations, the origination of over $1 billion of loans solidified the Company's leadership position and the ability to grow rapidly and efficiently was a testament to the Company's industry leading technology platform and strong execution were also false and misleading. In fact, as investors would discover after the Class Period, the Company's business model (i.e., solely originating credit card loans over the Internet) was a failure that resulted in the OCC placing NextBank into receivership.
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I. The False and Misleading 6/26/01 Press Release Announcing NextCard Had Exceeded One Million Customers and Reaffirming the Strength of the Company's Online Credit Card Business Model
101. False Statement: On 6/26/01 the Company issued a press release entitled, "NextCard Exceeds One Million Customers; Growth Reaffirms Strength of Online Credit Card Business Model." The press release stated in part:
"We intend to remain the premier choice for consumers who prefer to select a credit card through the Internet," said Hashman. "NextCard remains focused on building a truly differentiated and valuable customer experience. We are very happy that these million customers have chosen the NextCard Visa, and we will continue to innovate to provide them with even greater value."
"The Company is on track to meet our stated goal of break-even by the fourth quarter of this year. Our continued focus on our core business strategy and leadership position in Internet-based credit card lending is allowing us to build the foundation for a large and profitable business," he added.
102. Defendants' Knowledge of and Reasons Why the Statements Regarding the Company's Credit Card Business Model Were Materially False and Misleading: The statements contained in the 6/26/01 press release were materially false and misleading for the reasons set forth in ¶100. Specifically,
(a) the Company's statement that it had more than one million customers was misleading because many of those accounts were closed or had not been closed despite customer requests to do so;
(b) the statement that the Company was "on track" to "breakeven by the fourth quarter of this year" was known to be false. By the time the 6/26/01 press release was issued the OCC was well into the examination that started in 5/01. During that examination the OCC determined that the Company was operating in an unsafe and unsound manner and had experienced a substantial dissipation of assets and earnings through unsafe and unsound practices. Indeed, the OCC concluded that the unsafe and unsound practices were likely to deplete substantially all of the bank's capital and that there was no reasonable prospect for the bank to become adequately capitalized without federal assistance. The OCC also discovered the impropriety of classifying certain loan losses as fraud losses and the repurchase of those loans from securitization trusts. The OCC's examination finding directly contradicted the positive statements contained in the 6/26/01 press release.
J. Defendants' False and Misleading Statements Regarding NextCard's 2Q01 Financial Results
103. False Statement: On7/25/01, the Company issued another bullish press release announcing "strong results" for 2Q01. The press release stated in part:
NextCard, Inc. today announced strong results for the second quarter of 2001. Total managed revenue, which includes the impact of securitization activities, increased to $87.1 million. Operating revenue on a managed basis increased to $80.6 million for the quarter ended June 30, 2001, compared to $33.0 million for the quarter ended June 30, 2000 and $70.5 million for the quarter ended March 31, 2001. This represents an increase of 144 percent over the same period in 2000 and an increase of 14 percent over the previous quarter.
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Total managed loans rose over 115 percent to $1.789 billion as of June 30, 2001, compared to $829.7 million as of June 30, 2000, and rose 12 percent over the $1.595 billion in managed loans as of March 31, 2001. Total customer accounts increased over 129 percent to 1.016 million as of June 30, 2001, compared to approximately 443,000 customer accounts as of June 30, 2000, and increased 15 percent over the approximately 881,000 customer accounts as of March 31, 2001.
NextCard reported a second quarter net loss of $14.4 million, or a net loss per share of $0.27, beating First Call consensus estimates for the ninth consecutive quarter as a public Company. This compares to a net loss per share of $0.46 in the second quarter of 2000 and a net loss per share of $0.31 in the first quarter of 2001.
"Our second quarter results prove once again that the key drivers of our business are progressing ahead of expectations," said John Hashman, Chief Executive Officer. "We reported notably strong yield and margins, and solid growth as we surpassed the one millionth customer milestone during the quarter. As we grow, we are also very focused on continuing to build the industry's leading Internet-based risk management capabilities, including the introduction earlier this year of a new version of our proprietary credit scorecard. We are quite pleased with the delinquency trends coming from this new scorecard, as compared to prior versions of the model."
"As NextCard's business gains scale and margins improve, we expect our third quarter net loss will narrow to roughly one-half of the second quarter number," continued Hashman. "Today's results, combined with our third quarter expectations, demonstrate that we are clearly on track to meet our goal of profitability in the fourth quarter of this year. Our focus on our core business strategy and leadership position in technology-based credit card lending is allowing us to build the foundation for a large and profitable business."
* * *
The net charge-off rate for managed loans increased to 4.92 percent for the second quarter 2001, compared to 3.99 percent in the first quarter 2001. The delinquency rate (30+ days) on total managed loans increased to 5.25 percent as of June 30, 2001, compared with 4.75 percent as of March 31, 2001. The delinquency and charge-off rates are in-line with the Company's expectations given the natural seasoning of the loan portfolio and the general economic environment.
The Company continues to build its Internet-based risk management capabilities. The Company earlier this year implemented a new generation of its proprietary credit risk scorecard. The new scorecard is leading to substantially better credit quality, in terms of expected delinquency and loss rates, as compared to earlier versions of the model. The Company also enhanced its collections and recovery capabilities during the quarter.
NextCard continues to build strength on its balance sheet and maintain a strong cash position. The allowance for loan losses as a percentage of on-balance sheet loans increased to 6.10 percent as of June 30, 2001, compared to 5.08 percent as of March 31, 2001. Consolidated cash and liquid investments were $198.4 million as of June 30, 2001.
During the second quarter, NextCard completed the sale of $700 million of three-year floating rate asset-backed notes backed its credit card receivables. The securitization from the NextCard Credit Card Master Note Trust featured four classes of asset-backed notes, which
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were privately placed. The asset-backed securities provide NextCard with both a low-cost source of funding and the ability to achieve greater capital efficiency.
104. False Statement: The statements contained in the 7/25/01 press release were repeated to the market in reports issued by First Union analyst Whitney and Deutsche Banc analyst Zandi on 7/26/01. The statements were also repeated to the market in the Company's SEC Form 10-Q issued on 8/14/01 and signed by defendant Rigione.
105. Defendants' Knowledge of and Reasons Why the Statements Regarding the Company's 2Q01 Results Were Materially False and Misleading: The statements contained in the press releases, analysts' reports and SEC Form 10-Q were materially false and misleading for the reasons set forth in ¶102. Additionally,
(a) defendants knew the that NextCard's 2Q01 results were not "strong" and that the reported 2Q01 net loss of $14.4 million was false and misleading because the Company was not establishing sufficient loan loss allowances. Defendants continued to conceal the OCC's adverse examination findings and the 10/26/00 capital assurance agreement. They also concealed the OCC's current findings from the examination that began in 5/01, i.e., that the Company was operating in an unsafe and unsound manner and had experienced a substantial dissipation of assets and earnings through unsafe and unsound practices;
(b) defendants also knew that the Company's net interest income after provisions for loan loss allowances was not ($11.35) million as reported in the 7/25/01 press release and SEC Form 10-Q because NextCard did not establish sufficient loan loss allowances and because the Company was improperly classifying certain loan loss allowances as fraud losses and burying the fraud loss expense in other non-interest expense. Indeed, according to CW1, it was during 2Q01 that Hashman and Cai decided to improperly classify losses on "challenged bankruptcies" as fraud losses;
(c) defendants knew the statement that total customer accounts increased to 1.016 million was false and misleading because the Company was not closing accounts customers asked to be closed;
(d) in its SEC Form 10-Q and Call Report for 2Q01, NextBank reported risk based capital of $187.2 million, risk weighted assets of $1.1 billion and a risk based capital ratio of 17.35%. Defendants knew risk based capital was overstated because of the failure to establish sufficient loan loss allowances and the improper capitalization of credit card acquisition costs. Defendants knew risk weighted assets were understated by $1.2 billion because NextBank improperly excluded $1.2 billion of loans sold that did not qualify for low level recourse treatment;
(e) Hashman's statements that the Company's 2Q01 results proved the business was progressing ahead of expectations, the net loss in 3Q01 would be roughly one-half of the 2Q01 net loss and that NextCard was clearly on track to become profitable by 4Q01 were directly contradictory to the undisclosed examination findings by the OCC;
(f) the statement that the Company had substantially better credit quality was known to be false because defendants knew the statement conflicted with the OCC's examination findings and the rising delinquency and charge-off ratios reported by the Company, which, even though increasing, were understated due to the improprieties described above.
DEFENDANTS ADMIT THE COMPANY'S ONLINE CREDIT CARD BUSINESS MODEL WAS A FAILURE, THAT THE COMPANY NEEDED TO ESTABLISH SUBSTANTIAL LOAN LOSS ALLOWANCES AND THAT THE COMPANY HAD
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IMPROPERLY EXCLUDED MORE THAN $1 BILLION OF LOANS FROM ITS BOOKS
106. After reporting "extremely strong results" that beat consensus estimates for nine consecutive quarters, repeatedly telling investors that the Company's credit quality was "well under control" and representing to investors that the 3Q01 net loss would be one-half of the 2Q01 net loss, the Company, without warning, blindsided investors on 10/31/01 when it announced substantial problems with all facets of its business. On 10/31/01, the Company issued a press release entitled, "NextCard Retains Goldman Sachs to Pursue Sale of the Company; The Company Also Reports Operating Results for Third Quarter 2001 and New Regulatory Limitations." The press release stated in part:
Company Provides Additional Reserves and Limits Certain Operating Activities
The Company announced that it is taking several steps to increase reserves and limit certain lending activities of its wholly owned banking subsidiary, NextBank, N.A. (the "Bank"). These steps are being taken as a result of discussions with the Bank's regulators, the Office of the Comptroller of the Currency (the "OCC") and the Federal Deposit Insurance Corporation (the "FDIC," collectively with the OCC, the "Regulators"), as well as in consideration of the worsening economic situation. The Regulators are currently completing an examination of the Bank.
The increase in the Allowance for Loan Loss amount was developed in consultation with the Regulators to give full consideration to changes in economic conditions and the impact those effects may have on the portfolio. The Bank has increased the Allowance for Loan Losses by increasing its reserves to provide coverage for 12 months of projected losses, which is a more conservative approach to reserving for losses inherent in the portfolio.
As an additional result of the discussions with the Regulators, the Company has further tightened its underwriting criteria to limit new account originations to FICO scores above 680, suspended originations of secured credit cards, and suspended or limited certain line management programs, re-pricing programs, and fee-based product strategies.
The Bank also established a valuation reserve during the third quarter in the amount of $5.6 million to recognize the estimated uncollectible portion of accrued finance charges and fees on certain on-balance sheet loans that are more than 30+ days delinquent. Historically, and consistent with certain industry practice, these finance charges and fees were reversed against certain revenue upon charge-off of the related account.
The Bank has determined that, effective in the third quarter of 2001, it will classify as credit losses certain loan losses which were previously recognized as fraud losses and reflected as other expenses in the Company's financial statements. The Company believes that a substantial portion of these losses are related to fraudulent account origination activity specific to the Internet channel. As a result of discussions with the Regulators, the Company is developing an account level classification system to identify each fraudulent account in this category. Until such time that this classification system is fully developed, the Company will continue to classify these losses going forward as credit losses, and include them in its calculation of loan loss reserves.
In addition, the Regulators have notified the Bank that, as a result of the change in treatment of certain losses on loans sold through the Bank's securitization activities as fraud losses rather than credit losses, as described above, they have determined that the Company's
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securitization activities do not qualify for "low-level recourse treatment" under applicable regulations. The impact of the Regulators' decision to disallow low-level recourse treatment on the securitized assets was to increase the Bank's risk-weighted assets by approximately $537.5 million, to $2.1 billion as of September 30, 2001. The Bank is appealing this matter, which it does not believe is supported by regulatory guidelines. The Company cannot give any assurances as to whether this appeal will be favorably decided or the timing of any action on the appeal.
Finally, during the third quarter of 2001 the Bank expensed $35.7 million in certain capitalized intercompany acquisition costs previously expensed by the Company but still capitalized on the Bank's books. This change reduced the Bank's regulatory capital on a dollar-for-dollar basis but did not have any effect on the Company's consolidated financial statements.
Capital Ratios and the Bank
As a result of the increase in loan loss reserves, the elimination of low-level recourse treatment for securitized assets, the write-off of deferred acquisition costs and the Bank's reported loss for the third quarter 2001, the Bank's total risk-based capital ratio decreased to 5.38 percent of total risk-weighted assets as of September 30, 2001, as compared to 17.35 percent as of June 30, 2001. The Bank's Tier 1 risk-based capital ratio was 4.11 percent as of September 30, 2001, as compared to 15.69 percent, as of June 30, 2001, and the Bank's leverage ratio was 10.79 percent as of September 30, 2001, as compared to 18.55 percent as of June 30, 2001.
The Bank is now considered "significantly undercapitalized" under applicable federal banking regulations because its risk-based capital ratio has dropped below 6%. The Bank's Tier 1 and leverage capital ratios remain at amounts consistent with requirements for "well capitalized" banks. As a "significantly under-capitalized" institution, the Bank will be subject to Prompt Corrective Action (a "PCA") under applicable federal banking law. Under PCA provisions, the Bank must promptly submit an acceptable capital restoration plan to the OCC. In addition, the Bank is prohibited from increasing its average asset position above that established in the third quarter of 2001, will be prohibited from accepting or renewing any "brokered" deposits and must limit certain payments from the Bank to any affiliated entity. The Bank will also be subject to heightened regulatory scrutiny and prior approval requirements. Additional restrictions could be imposed on the Bank at the discretion of the OCC, without prior notice.
The Bank had previously agreed with OCC to maintain total capital of not less than 12 percent of risk-weighted assets, a level that exceeds the regulatory requirements for well-capitalized institutions. As of September 30, 2001, the Bank would have required approximately $140 million in additional regulatory capital to reach the 12 percent capital level committed to the OCC.
* * *
Third Quarter Operating Results
The Company today also announced operating results for the third quarter of 2001. Total managed revenue, which includes the impact of securitization activities, increased to $95.7 million. Operating revenue on a managed basis increased to $95.5 million for the quarter
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ended September 30, 2001, compared to $49.3 million for the quarter ended September 30, 2000. This represents an increase of 94 percent over the same period in 2000 and an increase of 19 percent over the previous quarter.
* * *
The Company's net loss for the third quarter of 2001 was $53.1 million, or $1.00 per share. This compares to a net loss per share of $0.38 in the third quarter of 2000 and a net loss per share of $0.27 in the second quarter of 2001.
* * *
Total loan charge-offs for the third quarter of 2001 were 7.89 percent. Excluding the change in fraud classification discussed above, loan charge-offs would have been 6.13 percent, compared to loan charge-offs of 4.92 percent for the second quarter of 2001. The delinquency rate (30+ days) on total managed loans increased to 5.90 percent as of September 30, 2001, compared to 5.25 percent as of June 30, 2001.
107. Investors and analysts were stunned at the extent and magnitude of the bad news. The Company's stock price collapsed, falling 84% from $5.35 on 10/30/01 to $0.87 on 10/31/01. Trading volume on 10/31/01 was 43.9 million shares compared to 414,600 the previous day. Analysts were furious at the extent of the adverse disclosures given the positive statements made by defendants during the Class Period. Deutsche Banc analyst Zandi issued a scathing report on 11/1/01 stating that management had "obvious credibility problems" and had misled when they previously insisted the Company was operated on a conservative basis with high credit quality and conservative accounting.
108. Additional events since the end of the Class Period further demonstrate defendants' fraud. In 3Q01 the Company reported a net loss of $53.1 million or ($1.00) earnings per share ("EPS"). Capital declined from $171.1 million at 6/30/01 to $118.6 million at 9/30/01. Risk based capital declined to $113.2 million or 5.4% of risk weighted assets, approximately $140 million less than that required by the capital assurance agreement.
109. On 11/15/01, the OCC issued a prompt corrective action directive requiring NextBank, inter alia, to file an acceptable capital restoration plan and to limit new credit card loans to applicants with FICO scores above 680. On 12/31/01 the Company submitted a capital restoration plan that conceded the Company would have to pursue a liquidation if it was unable to find a buyer. On 1/12/02 the Company notified the OCC that it was not possible to prepare and submit a capital restoration plan and submitted an asset disposition plan detailing the Company's plan to liquidate the assets and liabilities of NextBank. The plan disclosed that liquidation of the bank's assets would not raise enough money to retire in full the bank's existing and anticipated liabilities.
110. On 2/7/02 the OCC issued a press release announcing it had closed NextBank and appointed the FDIC as receiver. The OCC said it acted after finding that the bank was operating in an unsafe and unsound manner and had experienced a substantial dissipation of assets and earnings through unsafe and unsound practices. The OCC also stated that the unsafe and unsound practices were likely to deplete all of the bank's capital and that there was no reasonable prospect for the bank to become adequately capitalized without federal assistance. Just four days later, the FDIC mailed $525 million in checks to NextBank depositors. The FDIC has stated that it will not know the full cost to taxpayers until it sells the credit card portfolio.
111. After the OCC closed NextBank, the Company discontinued its credit card banking operations and
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reported a staggering net loss of $213 million for the year ended 12/31/01. The Company is now insolvent reporting negative capital of $9.8 million as of 3/31/02. The Company now provides administrative services to the FDIC pursuant to a 3/8/02 servicing agreement that can be terminated by the FDIC after 5/30/02, with not less than 30 days notice. The Company has disclosed that if the servicing agreement is terminated, NextCard will have insufficient cash to permit continued, sustained operations. The Company's auditor's report issued on 4/12/02 states there is substantial doubt about NextCard's ability to continue as a going concern.
112. The Company has reduced its workforce by 90%, laying off 546 employees. The Company's stock has been delisted from the NASDAQ, is worthless and currently trades at just pennies per share.
113. In addition to this suit, the OCC and FDIC have each initiated separate investigations into the events leading up to the closure of NextBank. On 5/8/02 the FDIC provided notice of potential claims against NextCard and unnamed officers and directors, and indicated that it continues to investigate the potential claims.
FALSE FINANCIAL STATEMENTS
114. In order to overstate its earnings in 2000 and 2001, NextCard violated GAAP and SEC rules by failing to properly report the value of its loans and accrued finance charges to reflect the large amounts of uncollectible assets in NextCard's balance sheet.
115. NextCard reported the following financial results for 2000 and 2001:
3/31/00 6/30/00 9/30/00 12/31/00 3/31/01 6/30/01 Net Loss ($17.7) M ($24.5) M ($20.3) M ($19.4) M ($16.6) M ($14.4) M Loss Per Share (.34) (.46) (.38) (.37) (.31) (.27) Allowance for Loan Losses 2.84% 3.16% 3.9% 3.16% 5.08% 6.10%
NextCard included these "reported" results in press releases and Form 10-Qs filed with the SEC.
116. These financial statements and the statements about them were false and misleading, as such financial information was not prepared in conformity with GAAP, nor was the financial information a fair presentation of the Company's operations due to the Company's improper accounting for its investment in NextBank, in violation of GAAP and SEC rules.
117. GAAP are those principles recognized by the accounting profession as the conventions, rules and procedures necessary to define accepted accounting practice at a particular time. 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. 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 statements. 17 C.F.R. §210.10-01(a).
118. According to GAAP, as set forth in SFAS No. 114, Accounting by Creditors for Impairment of a Loan, a loan is impaired when it is probable that a creditor will be unable to collect all amounts under contract. SFAS No. 114, ¶8 (amended by SFAS No. 118). GAAP, as described by FASB Statement of Concepts No. 5, requires that a loss be recorded for assets where expected benefits of an asset have been eliminated.
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119. During the Class Period, NextCard failed to record adequate reserves for uncollectible loans and accrued finance charges even as its risk of non-recovery increased. Because of NextCard's extension of credit through the Internet and its lack of history with its customers, it needed to use conservative estimates when valuing its extremely risky portfolio of credit card loan receivables and interest receivables. During the Class Period, it was experiencing increasing delinquencies and charge-offs, with charge-offs increasing to $13.2 million in the first six months of 2001 from $4.4 million in the first six months of 2000.
120. Ultimately, NextCard substantially increased loan loss reserves from $31 million at 6/30/01 to $71.6 million at 9/30/01. The Company also has written off $5.6 million for uncollectible accrued finance charges and fees and reclassified fraud losses as credit losses. The Company has also written off $35.7 million of improperly capitalized acquisition costs.
121. Due to these accounting improprieties, the Company presented its financial results and statements in a manner which violated GAAP, including the following fundamental accounting principles:
(a) The principle that interim financial reporting should be based upon the same accounting principles and practices used to prepare annual financial statements was violated (Accounting Principles Board Opinion ("APB") No. 28, ¶10);
(b) 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 was violated (FASB Statement of Concepts No. 1, ¶34);
(c) The principle that financial reporting should provide information about the economic resources of an enterprise, the claims to those resources, and effects of transactions, events and circumstances that change resources and claims to those resources was violated (FASB Statement of Concepts No. 1, ¶40);
(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 was violated. 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 (FASB Statement of Concepts No. 1, ¶50);
(e) The principle that financial reporting should provide information about an enterprise's financial performance during a period was violated. 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' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance (FASB Statement of Concepts No. 1, ¶42);
(f) The principle that financial reporting should be reliable in that it represents what it purports to represent was violated. That information should be reliable as well as relevant is a notion that is central to accounting (FASB Statement of Concepts No. 2, ¶¶58-59);
(g) The principle of completeness, which means that nothing is left out of the information that may be necessary to insure that it validly represents underlying events and conditions was violated (FASB Statement of Concepts No. 2, ¶79); and
(h) The principle that conservatism be used as a prudent reaction to uncertainty to try to ensure that
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uncertainties and risks inherent in business situations are adequately considered was violated. The best way to avoid injury to investors is to try to ensure that what is reported represents what it purports to represent (FASB Statement of Concepts No. 2, ¶¶95, 97).
122. Further, the undisclosed adverse information concealed by defendants during the Class Period is the type of information which, because of SEC regulations, regulations of the national stock exchanges and customary business practice, is expected by investors and securities analysts to be disclosed and is known by corporate officials and their legal and financial advisors to be the type of information which is expected to be and must be disclosed.
DEFENDANTS' INSIDER TRADING
123. As alleged herein, defendants acted with scienter in that defendants had actual knowledge 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 in the issuance or dissemination of such statements or documents as primary violators 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 NextCard, their control over and/or receipt and/or modification of NextCard's allegedly materially misleading statements and/or their associations with the Company which made them privy to confidential proprietary information concerning NextCard, participated in the fraudulent scheme alleged herein. This scheme: (a) deceived the investing public regarding NextCard's business, service capabilities, financial results, demand, growth, operations and the intrinsic value of NextCard securities; and (b) allowed Company insiders, several of whom are named as defendants herein, to sell 803,047 shares of their NextCard securities during the Class Period, while in possession of materially adverse, undisclosed information, allowing them to reap illicit proceeds of nearly $7 million and to profit from the artificial inflation in the price of NextCard stock which their scheme had created. The scheme also caused plaintiffs and other members of the class to purchase or otherwise acquire NextCard securities in a market in which the price of NextCard securities was artificially inflated.
124. Defendants' insider sales, while not necessary to establish their scienter in this case, are clearly probative of their knowledge and strengthen the already strong inference of scienter which is the result of their actual knowledge of the falsity of their statements.
125. In addition, the Individual Defendants had the motive and opportunity to commit the alleged fraud. As top management within the Company directly responsible for the false and misleading statements and/or omissions disseminated to the public through press releases, news reports, and investment analysts, the Individual Defendants had opportunity and were motivated to inflate the price of NextCard stock to enable the sale by insiders of vast quantities of NextCard stock. The Individual Defendants sold nearly $7 million worth of their own NextCard shares at prices as high as $10.89 per share, or 12 times the price to which NextCard shares dropped as NextCard's true prospects began to reach the market, as depicted in the chart below:
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126. As NextCard stock increased in price due to the false positive statements about NextCard's business detailed herein, NextCard insiders took advantage of this artificial inflation in NextCard's stock price by selling the following amounts of NextCard stock:
Insider Date Price Shares Value Y. Cai 3/7/01 9.580 13,377 $128,152 5/7/01 9.630 15,141 $145,808 8/6/01 7.790 19,119 $148,937 Total: 47,637 $422,897 J. Hashman 5/22/01 10.000 17,900 $179,000 7/30/01 7.960 17,900 $142,484 Total: 35,800 $321,484 J. Lent 2/15/01 10.130 44,000 $445,720 2/16/01 9.860 44,000 $433,840 2/20/01 9.170 44,000 $403,480 2/21/01 8.790 44,000 $386,760 2/22/01 8.370 44,000 $368,280 5/1/01 10.770 44,000 $473,880 5/2/01 10.890 44,000 $479,160 5/3/01 10.070 44,000 $443,080 5/4/01 9.990 44,000 $439,560
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5/7/01 9.560 44,000 $420,640 7/31/01 8.040 60,000 $482,400 8/1/01 8.020 50,000 $401,000 8/2/01 7.630 65,000 $495,950 8/3/01 7.730 57,300 $442,929 8/6/01 7.810 57,000 $445,170 8/7/01 7.700 65,000 $500,500 8/8/01 7.960 60,700 $483,172 Total: 635,000 $5,507,441 S. Qureshey 4/17/01 9.680 10,000 $96,800 4/18/01 10.250 5,000 $51,250 4/18/01 10.270 9,000 $92,430 4/19/01 10.400 5,000 $52,000 4/19/01 10.540 1,000 $10,540 7/17/01 9.470 3,100 $29,357 7/18/01 9.390 3,400 $31,926 7/18/01 9.470 3,000 $28,410 9/25/01 4.860 6,110 $29,695 9/25/01 4.830 5,000 $24,150 9/26/01 5.610 2,000 $11,220 9/26/01 5.610 2,000 $11,220 9/27/01 5.290 5,000 $26,450 9/27/01 5.270 5,000 $26,350 9/28/01 5.820 3,000 $17,460 10/1/01 5.610 2,000 $11,220 10/2/01 5.270 5,000 $26,350 Total: 74,610 $576,828 R. Linderman 2/7/01 9.611 10,000 $96,110
127. Defendants' sales as a percentage of their stock and vested options were as follows:
Defendant Total Holdings Sales % of Holdings Sold Y. Cai 324,267 47,637 14.11% J. Hashman 416,516 35,800 8.60% J. Lent 4,363,878 635,000 13.85% S. Qureshey 972,165 74,610 7.67% R. Linderman 95,720 10,000 10.45% Total 6,172,546 803,047 13.01%
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128. During the Class Period, the Individual Defendants sold an unusual number of shares relative to prior periods as indicated by the two charts below:
Defendants' Pre-Class and Class Period Sales
Difference in Class Period Shares Sold Relative to Prior Period
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129. The timing of defendants' sales was particularly suspicious. All of the sales were in 2001 after the OCC insisted upon the 10/26/00 capital assurance agreement that defendants concealed from investors. Moreover, many of the sales were in 2Q01 and 3Q01 after defendants improperly included "challenged bankruptcies" in fraud losses and during the second OCC examination that determined NextBank was operating in an unsafe and unsound manner.
130. The timing of defendants' trading practices was so suspicious that one of the leading financial information analysts, Thomson Financial Network ("Thomson"), ranks defendants as "all-star" inside traders. Thomson conducts extensive statistical analysis of the sales by insiders and ranks insider sales by the price changes that occur after each insider's trade. This ranking information is accessible over the Internet at http://insider.thomsonfn.com/tfn/insider.asp. Thomson's analysis demonstrates that defendants' trades are suspicious in that the price of the stock, on average, drops dramatically after defendants' sales. Thomson's analysis suggests that defendants' trading has historically occurred at very suspicious times - immediately preceding a decline in the price of NextCard Systems - exactly what occurred in this case - suggesting either incredibly lucky timing or the systematic use of insider information when trading.
CLASS ACTION ALLEGATIONS
131. This is a class action on behalf of purchasers of NextCard publicly traded securities during the Class Period (the "class"). Excluded from the class are officers and directors of the Company, as well as their families and the families of the defendants. Class members are so numerous that joinder of them is impracticable.
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132. Common questions of law and fact predominate and include whether defendants: (i) violated the 1934 Act; (ii) omitted and/or misrepresented material facts; (iii) knew or recklessly disregarded that their statements were false; and (iv) artificially inflated the prices of NextCard's publicly traded securities and the extent of and appropriate measure of damages.
133. Plaintiffs' claims are typical of those of the class. Prosecution of individual actions would create a risk of inconsistent adjudications. Plaintiffs will adequately protect the interests of the class. A class action is superior to other available methods for the fair and efficient adjudication of this controversy.
CLAIM FOR RELIEF FOR VIOLATION OF SECTION 10(b) OF THE 1934 ACT AND RULE 10b-5 AGAINST ALL DEFENDANTS
134. Plaintiffs incorporate ¶¶1-133 by reference.
135. Defendants violated §10(b) and Rule 10b-5 by:
(a) Employing devices, schemes and artifices to defraud;
(b) Making untrue statements of material facts and omitting to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; and
(c) Engaging in acts, practices and a course of business that operated as a fraud or deceit upon the class in connection with their purchases of NextCard publicly traded securities.
136. Class members were damaged as they paid artificially inflated prices for NextCard's publicly traded securities in reliance on the integrity of the market.
CLAIM FOR RELIEF FOR VIOLATION OF SECTION 20(a) OF THE 1934 ACT AGAINST ALL DEFENDANTS
137. Plaintiffs incorporate ¶¶1-136 by reference.
138. The Individual Defendants prepared, or were responsible for preparing, the Company's press releases and SEC filings. The Individual Defendants controlled other employees of NextCard. NextCard controlled the Individual Defendants and each of its officers, executives and all of its employees. By reason of such conduct, the Individual Defendants and the Company are liable pursuant to §20(a) of the 1934 Act.
PRAYER FOR RELIEF
WHEREFORE, plaintiffs, on behalf of themselves and the class, pray for judgment as follows:
A. Declaring this action to be a class action properly maintained pursuant to Rule 23 of the Federal Rules of Civil Procedure;
B. Awarding plaintiffs and other members of the class damages together with interest thereon;
C. Awarding plaintiffs and other members of the class costs and expenses of this litigation, including reasonable attorneys' fees, accountants' fees and experts' fees and other costs and disbursements;
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and
D. Awarding plaintiffs and other members of the class such equitable/injunctive or other and further relief as may be just and proper under the circumstances.
JURY DEMAND
Plaintiffs demand a trial by jury.
DATED: June 17, 2002 MILBERG WEISS BERSHAD HYNES & LERACH LLP JEFFREY W. LAWRENCE CHRISTOPHER P. SEEFER
______CHRISTOPHER P. SEEFER
100 Pine Street, Suite 2600 San Francisco, CA 94111 Telephone: 415/288-4545 415/288-4534 (fax)
MILBERG WEISS BERSHAD HYNES & LERACH LLP WILLIAM S. LERACH 401 B Street, Suite 1700 San Diego, CA 92101 Telephone: 619/231-1058 619/231-7423 (fax)
BERNSTEIN LITOWITZ BERGER & GROSSMANN LLP ALAN SCHULMAN 12544 High Bluff Drive, Suite 150 San Diego, CA 92130 Telephone: 858/793-0070 858/793-0323 (fax)
BERNSTEIN LITOWITZ BERGER & GROSSMANN LLP DOUGLAS M. McKEIGE 1285 Avenue of the Americas, 33rd Floor New York, NY 10019 Telephone: 212/554-1400 212/554-1444 (fax)
Co-Lead Counsel for Lead Plaintiffs and the Class
DECLARATION OF SERVICE BY FACSIMILE
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PURSUANT TO NORTHERN DISTRICT LOCAL RULE 23-2(c)(2)
I, the undersigned, declare:
1. That declarant is and was, at all times herein mentioned, a citizen of the United States and a resident of the County of San Francisco, over the age of 18 years, and not a party to or interest in the within action; that declarant's business address is 100 Pine Street, 26th Floor, San Francisco, California 94111.
2. That on June 17, 2002, declarant served by facsimile the CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS to the parties listed on the attached Service List and this document was forwarded to the following designated Internet site at:
http://securities.milberg.com
3. That there is a regular communication by facsimile between the place of origin and the places so addressed.
I declare under penalty of perjury that the foregoing is true and correct. Executed this 17th day of June, 2002, at San Francisco, California.
______Pamela Jackson
1. The figures for Net Interest Income, LLA Provision and Net Interest Income were contained in the Company's SEC filing. The fraud loss provisions were derived from or reported in NextBank's FFIEC Call Reports.
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