More Subprime Executive Hanky Panky

The folks at NovaStar Financial (stock symbol NFI) have had a tough year. The stock was as high as $125 per share this year and had an all-time high of over $200 per share. It now trades at $1.24.  Ouch!  Not only that, the New York Stock Exchange has told the company it may de-list their stock. Here’s the chart for the last year.

What was most interesting was what was going on with compensation of executives. In the 2006 annual report, it took over 20 pages to discuss compensation.

The proxy statement contained the following statement:

On June 8, 2004, the Company’s 1996 Stock Option Plan (the "1996 Plan") was replaced by the 2004 Incentive Stock Plan ("the 2004 Plan"). The 2004 Plan provides for the grant of qualified incentive stock options ("ISOs"), non-qualified stock options ("NQSOs"), deferred stock, restricted stock, performance share awards, dividend equivalent rights ("DERs") and stock appreciation and limited stock appreciations awards ("SARs").

I must say here that those guys had figured out about every way they could to take money out of the company. What interested my most were that DERs, Dividend Equivalent Rights.

Let’s back up a minute. Normally when stock options are granted, they "vest" at a certain rate. You can’t exercise an option until it vests. Let’s say you were given options 10,000 shares. They might vest at the rate of 20% per year so that each year you could exercise 2,000 shares. But to exercise the option, you’d have to come up with the money and buy it, right?

But DERs make it more fun. As the were explained to me, DERs give you the right to receive dividends on those shares, even though you don’t actually own them. In our example, let’s say after 3 years 6,000 shares had vested.  Even though you didn’t own the shares, you could get paid the stock’s $5.60 per share dividend, a total of $33,600.   

With the stock tanking, those options would ultimately become worthless, but if you had DERs, you could keep collecting dividend income at the expense of the other shareholders.

Now that’s small potatoes to an executive making over $1,000,000 per year, but still, if you were a shareholder, you might wonder about this equity of this kind of plan.

I don’t know the ultimate outcome of the NovaStar situation but the two top guys owned 2,000,000 shares. When the stock was $200 per share, they were worth $400 million. Today, those shares are worth a mere. $2,480,000.  And the DERs aren’t worth anything as the company has suspended its dividend.

This is the final article about this topic. Makes me sick, frankly.  There are many more stories,including ones about FannieMae and FreddieMac where management was "cooking the books," over-stating income by billions so as to collect bigger bonuses.

What is clear is that when you see the hanky panky in the Executive Suite, you can understand why it was tolerated throughout the organization. That hanky panky is going to cost a lot to clean up. I was shocked to hear a report from Wall Street that estimates the total losses might be as high as $400 billion!! You will pay a portion of that somewhere along the line in your home’s value or 401(k) or your job. 

What I would hope you would learn from this is that it IS important to understand the ethics of the company and individual you choose to do business with. Millions of borrowers did not exercise due diligence and they are paying the price. Make sure that this doesn’t ever happen to you.

Randy Johnson Randy is a Credit.com contributor and seasoned mortgage expert. He writes about home buying, mortgage laws and real estate finance issues. He has financed over $1 billion in properties, is the author of How to Save Thousands of Dollars on your Home Mortgage and he is a feature columnist for Savvy Borrower.