TRENTON, N.J. -- A class action lawsuit has been filed on behalf of shareholders of Hovnanian Enterprises Inc. alleging violation of the Securities and Exchange Act of 1934. In August 2005, Hovnanian bought First Home Builders of Florida, the developer that built homes in Cape Coral and Lehigh Acres, many of which were funded by credit unions.

The case, filed earlier this month in the U.S District Court for the District of New Jersey here, claims that through public statements, publicly filed documents, news releases and news interviews, Hovnanian employees, including Ara Hovnanian, CEO, J. Larry Sorsby, chief financial officer, and Bruce Robb, chief operating officer of First Home Builders of Florida, misled shareholders about the extent of liability the company faced from the Florida real estate downturn.

The suit states that shareholders were kept in the dark about how "the FHB acquisition was plagued with a series of major problems which Hovnanian did not disclose, and later only partially disclosed ... all of which negatively affected the company's financial performance." Instead, a more positive outlook was described by executives from August 2005 through December 2007.

FHB's strong sales backlog was touted, rather than an accounting of the problems associated with the acquisition. "Unbeknownst to the investing public, the FHB backlog consisted of highly speculative and legally questionable contracts that were prone to buyer cancellation," claims the suit. The backlog was "permeated" with investors who purchased multiple homes, and Hovnanian was either "reckless" in not making the risk known to shareholders or knew of the risk and kept it hidden.

To maintain the illusion of a profit potential, the suit claims that the company said its sales contracts for FHB homes were backed by construction loans that covered 80% of the home price but kept secret that buyers were not responsible for making interest payments on those loans nor for paying property insurance. Similarly, Hovnanian and FHB allowed buyers to enter into contracts making less than a minimum down payment. Further, it alleges, those buyers were coached and gave falsified financial data.

Riding the Boom Times

Hovnanian benefited from the real estate boom years from 2002 through mid-2004 and went on an acquisition spree, amassing 14 other companies, including FHB in August 2005. It was one of Florida's biggest builders and top in the southwest part of the state. In a press release at the time, Hovnanian said FHB had an excellent reputation and a strong track record of financial performance. The state's growing population and strong job market made it attractive for the foreseeable future, it added.

According to the suit, two realtors, Frank D'Allessandro and Tom Woodyard worked with FHB to sell "leased-up" homes they told investors would bring double-digit returns. Using leads from its model centers, they found people, many who could not qualify for a mortgage, and recruited them to rent the homes the realtors sold to others. The "ready-made" tenant would later buy the house from the owner. The homebuyers only had to make a low down payment and mortgage the rest, and many were encouraged to buy multiple homes. The realtors guaranteed a 14% rate of return in its prospectus.

The amount of the construction loans, many provided by credit unions, was also inflated and fashioned by FHB to include the full purchase price, including sales profit. And higher deposits normally required on the purchase of second homes were overlooked, according to the lawsuit. The last step in the scheme was the renter buyout, when a subprime loan was secured after the renter qualified by leasing for 12 months. But when these renters never materialized the buyers began to walk away.

"FHB's backlog was fueled by its unusual financing arrangement with First American Mortgage Inc., Norlarco Credit Union and a series of other credit unions," states the lawsuit. Norlarco, Huron River, New Horizons, and dozens of other CUs (through participation agreements) "eventually suffered severe losses relating to the Fort Myers FHB loans. Three of these credit unions eventually collapsed and were taken over by the NCUA."

The NCUA now holds more than $438 million in loans tied to these Florida loans, many from Norlarco. Making matters worse, Hovnanian dropped the insurance coverage on the Norlarco loans forcing the NCUA to insure the properties.

In 2003, Norlarco had a funding agreement with First American Mortgage in place to buy loans from FHB. In October 2004 FHB had an agreement with First American that guaranteed it would make interest payments on those loans until the buyer got permanent financing. That guarantee "created little risk for Norlarco purchasing the loans," says the suit, and allowed FHB to "magnify its backlog of home sales contracts."

But the agreement was amended two months before Hovnanian announced its purchase of Florida Homes (June 2005), contradicting and eliminating the guarantee. The suit alleges that this guarantee was discovered by Hovnanian during its due diligence process, and the company insisted it be reversed.

"Defendants pursued a course of deceptive conduct" and as the housing bubble began to deflate were aware of the position the FHB acquisition placed the company in and "concealed its irreparable harm," according to the lawsuit. Instead, Hovnanian blamed the overall market downturn and sought to minimize the flow of bad news to protect their own "lucrative compensation."

The suit asks for compensatory damages and injunctive relief, attorney's fees and any equitable relief the court may deem just and proper.

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