In Re NetBank, Inc. Securities Litigation 07-CV-02298 ...securities.stanford.edu/filings-documents/1038/NTBKPK_01/200873_r... · Case 1:07-cv-02298-BBM Document35 Filed 07/03/2008

Case 1:07-cv-02298-BBM Document 35 Filed 07/03/2008 Page 1 of 73

IN THE UNITED STATES DISTRICT COURTFOR TIIE NORTHERN DISTRICT OF GEORGIA

ATLANTA DIVISION

IN RE NETBANK, INC.SECURITIES LITIGATION

Civil Action No. 1:07-cv-2298

Complaint - Class Action

Jury Trial Demanded

CONSOLIDATED AND AMENDEDCLASS ACTION COMPLAINT

Lead Plaintiff Robert A. Brown ("Plaintiff' or "Lead Plaintiff'), by and

through his undersigned attorneys, individually and on behalf of all other persons

similarly situated who purchased or acquired NetBank, Inc. ("NetBank" or the

"Company") common stock during the period March 16, 2005 through and including

May 21, 2007 (the "Class Period") and were damaged thereby, as and for his

Amended and Consolidated Class Action Complaint (or "Amended Complaint"),

alleges as follows:


TABLE OF CONTENTS

1. NATURE AND GENERAL OVERVIEW OF THE CLAIMS .......... 4

II. BASIS OF ALLEGATIONS .................................... 10

III. JURISDICTION AND VENUE ................................. I I

IV. NETBANK, INC. - THE BANKRUPT CORPORATE ENTITY ....... 12

V. THE PARTIES .............................................. 18

VI. OTHER RELEVANT PERSONS AND ENTITIES .................. 23

VII. CLASS ACTION ALLEGATIONS .............................. 33

VIII. ADDITIONAL SUBSTANTIVE ALLEGATIONS .................. 37

A. Corporate History of NetBank ............................. 37

B. NetBank' s Business Segments ............................. 38

C. Overview of Bank Mortgage Lending ....................... 41

IX. DEFENDANTS' ADDITIONAL FALSE ANDMISLEADING STATEMENTS ................................. 44

A. NetBank's Surreptitious Transition From Its Core Banking

Operations to the Subprime Mortgage Market ................. 44

B. Defendants ' Sham Restructuring of NetBank ................. 74

C. Defendants Falsely Assure Investors That TheyCan Rely on NetBank's Book Value ........................ 86

D. Defendants Make Additional False Assurances

to Investors After E&Y Resigns ............................ 90

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E. NetBank Continues to Falsely Reassure InvestorsAbout the Company's Condition and Operations ............. 104

F. NetBank Misleads Investors Regarding the Validity

of Its FAS 133 Accounting ............................... 115

X. THE TRUTH REGARDING DEFENDANTS' FRAUDBEGINS TO EMERGE ....................................... 123

XI. GAAP VIOLATIONS ........................................ 139

A. Lack of Adequate Internal Controls ..... ................... 142

B. Understatement of Representations and Warranties Liability .... 162

C. Undisclosed Impairment of Goodwill ...................... 175

D. Overstatement of Mortgage Servicing Rights Valuation ........ 182

F. Ineffective Disclosure of Controls and Procedures ............ 186

XII. ADDITIONAL SCIENTER ALLEGATIONS ..................... 189

XIII. LOSS CAUSATION/ECONOMIC LOSS ........................ 191

XIV. FRAUD ON THE MARKET DOCTRINE ........................ 196

XV. INAPPLICABILITY OF SAFE HARBOR ....................... 199

CLAIMS FOR RELIEF:

COUNT I - Violation of Section 10(b) of the Exchange Act andSEC Rule 10b - 5 Against All Defendants ........ ....... 200

COUNT II - Violation of Section 20(a) of the Exchange ActAgainst the Individual Defendants .................... 205

PRAYER FOR RELIEF AND JURY DEMAND ........................ 206

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Case 1 : 07-cv-02298-BBM Document 35 Filed 07/03/2008 Page 4 of 73

1. NATURE AND GENERAL OVERVIEW OF THE CLAIMS

1. This is a federal securities law class action brought against NetBank's

senior officers and directors, including Douglas K. Freeman, James P. Gross, Steven

F. Herbert, Thomas H. Muller, Jr., Eula L. Adams, David W. Johnson, Jr., and

Catherine A. Ghiglieri (collectively, the "Defendants").

2. During the Class Period, Defendants engaged in a fraudulent scheme to

artificially inflate the price ofNetBank's publicly-traded common stock, in violation

of the federal securities laws, §§ 10(b) and 20(a) of the Securities Exchange Act of

1934 (the "Exchange Act") and Rule I Ob-5 promulgated thereunder.

3. Plaintiff alleges, in sum, that Defendants defrauded Class members by

making materially false and misleading statements and omissions regarding the

financial results, operations and condition ofthe Company, which artificially inflated

the price of NetBank common stock during the Class Period. As a result of those

statements and omissions, the Company's stock traded at artificially inflated levels

during the Class Period -- trading as high as $8.74 per share on March 16, 2005.

However, by the end of the Class Period, the Company's stock had evaporated to a

mere $0.59 per share on May 21, 2007.

4. As the Country's oldest internet bank, NetBank claimed early successes

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in supposedly being transformed following its 2001 acquisition of Market Street

Mortgage Corporation, and its conservative line of residential mortgages. Shortly

thereafter, NetBank changed its conservative course when in 2002 it acquired

Resource Bancshares Mortgage Group ("RBMG"), and that entity's risky subprime

mortgage subsidiary, Meritage Mortgage Corporation. In connection with that

acquisition , RBMG's Chief Executive Officer ("CEO") and Chief Financial Officer

("CFO"), defendants Freeman and Herbert, assumed those same roles with the "new"

NetBank, ousting NetBank's more conservative CEO, D.R. Grimes.

5. At that time ofthe 2002 RBMG acquisition, NetBank's banking business

was only marginally pro f table. In a desperate and reckless effort to grow at all costs,

Defendants moved to then essentially transform NetBank into a high risk mortgage

company -- thereby abandoning the conservative mortgages favored by former CEO

Grimes and instead relying and expanding upon subprime and other risky mortgage

lending as the primary means of generating income from the Company's $2 billion

bank deposit base.

6. As a result, defendants Freeman and Herbert -- NetBank's "new"

management -- created a corporate culture that blindly focused its emphasis on

earnings growth and at least creating the impression that its products and services

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were revolutionary. In executing a plan to reinvent NetBank, Defendants essentially

attempted to leverage the Company's deposits with inherently risky subprime loans

and other business segments, in order to create the false impression that the

Company's efforts to diversify and capitalize on its banking deposits were successful.

7. In doing so, Defendants implemented a series ofpolicies, procedures and

practices that failed to comply with Generally Accepted Accounting Principles

("GAAP"), and thereby falsely portrayed the Company ' s earnings, overvalued its

mortgage assets, undervalued its subprirne exposures and misaccounted for its

hedging activities. NetBank's resulting misrepresentations and omissions were made

by, approved by and/or implemented by each of the Defendants, who include the

Company's senior operational officers and its Audit Committee.

8. Beginning in March 2005, NetBank filed with the United States

Securities and Exchange Commission ("SEC") the Company's 2004 Form 10-K,

which falsely reported not only the Company's financial results, but also its business

operations and corporate restructuring. Thereafter, Defendants made continuing

misstatements and omissions to the investing public, in which they claimed that the

Company was successfully restructuring and reporting properly its financial results

and condition.

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9. In May 2006, Defendants made a series of representations to the

investing public in which they claimed that NetBank was then successfully

restructuring its operations to eliminate high-risk non-conforming loan origination

operations and other failing business segments. These representations were highly

material and impacted the perceived value of NetBank's common stock, because the

Company also claimed that it had a strong core banking business that would

substantially benefit from the elimination of the high-risk, non-conforming loan

origination segment . The Defendants claimed that the restructuring was substantially

complete by February 2007. At that time, Defendants also represented that investors

could rely on the book value of the Company as an accurate reflection ofNetBank's

true value. Those representations were false.

10. On November 9, 2006, NetBank revealed that its outside auditor, Ernst

& Young (or "E&Y"), would be resigning after the Company filed its Form 10-Q for

3Q2006, which was then made on November 9, 2006. Although this information was

not previously made public, Defendants had known this since October 10, 2006.

Moreover, the Company and E&Y falsely claimed that no material disputes led to the

resignation . On February 16, 2007, NetBank announced that the Company had

retained a new outside auditor. Defendants falsely assured investors by stating that

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the filing of its 2006 annual report on Form l 0-K would simply be delayed as a result

of this transition.

11. On May 21, 2007, NetBank shocked the market when. it announced that,

contrary to its prior public representations, its core banking business was in fact

highly deficient and that the Company had failed to meet its regulatory capital

requirements. Netl3ank further disclosed that, as a result of this significant deficiency

in its core banking business, banking regulators were forcing the Company to

consummate a sale of its $2.5 billion of core and brokered deposits, its held for

investment loan portfolio, all of the assets and liabilities of NetBank Business

Finance, the Company' s small business equipment leasing and financing operation,

and the NetBank brand and related trademarks and service marks. NetBank reported

that the forced sell-off would result in a loss of $60-70 million . In. other words,

NetBank was being forced to liquidate at a loss its core banking operations and nearly

all of the remainder of its business segments. These disclosures were effectively

admissions that the Company's books and valuations were grossly overstated and

misstated, and that not only had NetBank failed to account properly for its mortgage

business but that even its "core" banking business was on the verge of collapse.

Unsurprisingly, as a result of these devastating disclosures, the Company's common

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stock price plummeted 66%, from $1.75 per share on May 18, 2007 to $0.59 per

share on May 21, 2007.

12. Thereafter, on August 6, 2007, NetBank filed a Form 8-K with the SEC

that reported that the entire carrying amount of goodwill for the Company's wholly-

owned retail mortgage business , Market Street, would have to be written off, resulting

in an impairment charge of $24.6 million.

13. NetBank then continued to claim that the transition to its new auditor

was delaying the filing of its 2006 Form 10-K, and even its Forms 10-Q for 1 Q2007

and 2Q2007. Indeed, since E&Y resigned in November 2006, NetBank failed to file

any of its requisite financial reports with the SEC. As a result, the NASDAQ

repeatedly threatened and ultimately did delist NetBank's stock on August 7, 2007.

14, On August 10, 2007, NetBank filed a Form 12b-25 which reported that

E&Y had withdrawn its audit opinions for the Company's prior Forms 10-K for 2004

and 2005, based on the Company's misapplication of Statement of Financial

Accounting Standard ("FAS" or "SFAS") 133, and that investors should no longer

rely on NetBank's financials. The Company also admitted that it had withheld the fact

that the SEC had been investigating the Company' s accounting practices since at least

August 31, 2006 -- nearly one year prior. Not only did Defendants fail to disclose

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publicly the SEC investigation, Defendants also failed to disclose that they were

unable or unwilling to correct NetBank's accounting and produce accurate financial

reports.

15. Ultimately, Defendants failed to file publicly with the SEC any financial

statements following the 3Q2006 results the Company filed in November 2006. In an

effort to conceal their fraud, Defendants also withheld making any financial

restatement for its prior financial results -- and allowed instead for the Company's

stock to be delisted, and for the Office of Thrift Supervision' ("OTS") to finally step

in and shut down NetBank's operations on September 28, 2007. By that time,

NetBank's common stock was rendered valueless, the Company sought bankruptcy

protection, and NetBank's investors had become fraud victims of the first bank

failure infiveyears, the largest bankfailure since] 993 and the largest bank failure

in the history ofthe State of'Geoxgia.

Il. BASIS OF ALLEGATIONS

16. Plaintiff makes the allegations herein, other than those concerning

himself, based upon the investigation of Plaintiff's counsel. Said investigation

' The OTS is the primary federal regulator of federally chartered andstate-chartered savings associations, their subsidiaries, and their registered savingsand loan holding companies.

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included a review of various filings with the SEC, press releases issued by the

Company, media reports concerning the Company, publicly disseminated documents

concerning the Company's business practices, securities analysts' reports and

advisories about the Company, pleadings and other documents filed in other

litigations involving NetBank, and certain other public filings and documents, as well

as interviews with former employees of NetBank (some of whom are referenced

herein as confidential witnesses). Moreover, the Company has admitted to certain of

the wrongful acts and practices alleged herein; those admissions also serve as a basis

for Plaintiff's allegations. Plaintiff believes that additional evidentiary support will

exist for his allegations after he is afforded a reasonable opportunity for discovery.

III. JURISDICTION AND VENUE

17. This Court has jurisdiction over the subject natter ofthis action pursuant

to Section 27 of the Exchange Act (15 U.S.C. § 78aa) and 28 U.S.C. § 1331. The

claims asserted herein arise under sections 10(b) and 20(a) of the Exchange Act, §

78j(b) and 78t(a), and SEC Rule lOb-5, 17 C.F.R. § 240.1Ob-5.

18. Venue is proper in this District pursuant to Section 27 of the Exchange

Act (15 U.S.C. § 78aa) and 28 U.S.C. § 1391(b) and (c). Many of the acts and

transactions giving rise to the violations of law complained of herein, including the

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preparation and dissemination to the investing public of materially false and

misleading information, occurred within this District, and NetBank maintained its

principal place of business in Alpharetta, Georgia.

19. In connection with the acts, omissions, conduct and other wrongs alleged

in this Amended Complaint, all. ofthe defendants, directly and/or indirectly, used the

means and instrumentalities of interstate commerce including the mail, the Internet,

interstate telephone cormnunications, and the facilities of national securities markets

and exchanges.

IV. NETBANK, INC. - THE BANKRUPT CORPORATE ENTITY

20. NetBank, Inc. was incorporated in the state of Georgia and maintained

its executive offices at 1015 Windward Ridge Parkway, Alpharetta, Georgia 30005.

a. NetBank was founded in 1996 and represented itself as a financial

holding company that operated a family ofbusinesses focused primarily on consumer

and small business banking. By 2007, at the time of NetBank's demise, the

Company's retail banking franchise, NetBank, FSB, was the nation's oldest active

Internet bank serving retail and business customers in all 50 states.

b. In addition to its core banking business, NetBank owned several

subsidiaries including: NetBank, FSB ("NetBank, FSB"), a federal savings bank;

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MG Reinsurance Company ("MG Reinsurance"), a captive reinsurance company;

Netlnsurance, Inc. ("Netlnsurance"), a licensed insurance agency; and NB Partners,

Inc. ("NB Partners"), a corporation involved in so-called strategic partnering

opportunities. Netbank, FSB owned, during all or part of the Class Period, all of the

outstanding common stock of: Market Street Mortgage Corporation ("Market

Street"), a retail mortgage company; NetBank Payment Systems, Inc. ("NBPS"), a

provider of ATM and merchant processing services for retail and other non-bank

businesses ; Meritage Mortgage Corporation ("Meritage"), a wholesale non-

conforming mortgage provider ; and Financial Technologies, One a provider

of transaction processing services to financial services companies. NetBank, FSB's

wholesale mortgage division operated as NetBank Funding Services ("Netbank

Funding"); its business financing division operated as "NetBank Business Finance";

its automobile financing division operated as "Dealer Financial Services"; and its

recreational vehicle financing division operated as "Beacon Credit Services."

c. As of February 21, 2007, there were 46,425,000 outstanding

shares of NetBank, Inc. The Company's shares were traded on the National

Association of Securities Dealers Automated Quotations ("NASDAQ") securities

exchange, an open and efficient market. The Company's stock traded on the

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NASDAQ, from 1997 until its delisting on August 7, 2007, under the symbol

"NTBK"

d. NetBarik had been named as a defendant in the initial class actions

captioned Adcock v. iVetBank, Inc., et cxl.,1:07-cv-02298-BBM (N.D. Ga.) and Vahdat

v. NetBank, Inc., et cil., 1 :07-cv-026 31. -BBM (N.D. Ga.). Under the Court's Order

entered in the instant proceedings on April 21, 2008 (Docket no. 32), those actions

and all other such class actions were consolidated. However, since the filing of the

Adcock action, NetBank filed for protection under Chapter 11 of the federal

bankruptcy laws. See In re llreiBank, Inc., No. 3:07-bk-04295-JAF (M.D. Fla. Bankr.,

filed September 28, 2007). In adherence to the automatic stay under the bankruptcy

laws (11 U.S.C. § 362(a)), NetBank has not been joined as a defendant in this

Amended Complaint.

21. During the Class Period, NetBank carried out a plan, scheme and course

of conduct which was intended to and, throughout the Class Period, did: (i) deceive

the investing public regarding the Company's business, operations, management and

the intrinsic value of NetBank securities; and (ii) cause Plaintiff and other members

of the Class to purchase NetBank's securities at artificially inflated prices. In

furtherance of this unlawful scheme, plan and course of conduct.

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22. NetBank: (a) employed devices, schemes, and artifices to defraud;(b)

made untrue statements of material fact and/or omitted to state material facts

necessary to make the statements not misleading; and (c) engaged in acts, practices,

and a course of business which operated as a fraud and deceit upon the purchasers of

the Company's securities in an effort to maintain artificially high market prices for

NetBank's securities in violation of Section 10(b) ofthe Exchange Act and Rule 1 Ob-

5 promulgated thereunder.

23. NetBank, individually and in concert with the Defendants, directly and

indirectly , by the use, means or instrumentalities of interstate commerce and/or ofthe

mails, engaged and participated in a continuous course of conduct to conceal adverse

material information about the business, operations and future prospects of the

Company as specified herein,

24. NetBank employed devices, schemes and artifices to defraud, while in

possession ofmaterial adverse non-public information and engaged in acts, practices,

and a course of conduct as alleged herein in an effort to assure investors of the

Company's value andperformance and continued substantial growth, which included

the making of, or the participation in the making of, untrue statements of material

facts and omitting to state material facts necessary in order to make the statements

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made about the Company and its business operations and future prospects in the light

of the circumstances under which they were made, not misleading, as set forth more

particularly herein, and engaged in transactions, practices and a course of business

which operated as a fraud and deceit upon the purchasers of NetBank's securities

during the Class Period.

25. NetBank had actual knowledge of the misrepresentations and omissions

ofmaterial facts set forth herein, or acted with reckless disregard for the truth in that

it failed to ascertain and to disclose such facts, even though such facts were available

to it . NetBank's material misrepresentations and/or omissions were done knowingly

or recklessly and for the purpose and effect of concealing the Company's operating

condition and future business prospects from the investing public and supporting the

artificially inflated price of its securities. As demonstrated by NetBank's

overstatements and misstatements of the Company's business, operations and

earnings throughout the Class Period, NetBank, if it did not have actual knowledge

of the misrepresentations and omissions alleged, was sufficiently reckless in failing

to obtain such knowledge by deliberately refraining from taking those steps necessary

to discover whether those statements were false or misleading.

26. As a result of the dissemination of the materially false and misleading

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information and failure to disclose material facts, as set forth above, the market prices

ofNetBank's securities were artificially inflated during the Class Period. In ignorance

of the fact that market prices ofNetBank's publicly-traded securities were artificially

inflated, and relying directly or indirectly on the false and misleading statements

made by NetBank, or upon the integrity of the market in which the securities trade,

and/or on the absence ofmaterial adverse information that was known to or recklessly

disregarded by NetBank but not disclosed in public statements by NetBank during the

Class Period, Plaintiff and the other members of the Class acquired NetBank

securities during the Class Period at artificially high prices and were damaged

thereby.

27. At the time of said misrepresentations and omissions , Plaintiff and other

members ofthe Class were ignorant of their fal sity, and believed them to be true. had

Plaintiff and the other members of the Class and the marketplace known the truth

regarding NetBank' s financial results, which were not disclosed by Defendants,

Plaintiff and other members of the Class would not have purchased or otherwise

acquired their NetBank securities,. or, if they had acquired such securities during the

Class Period, they would not have done so at the artificially inflated prices which they

paid.

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28. By virtue of the foregoing, NetBank violated Section 10(b) of the

Exchange Act, and Rule IOb-5 promulgated thereunder. As a direct and proximate

result of NetBank's wrongful conduct, Plaintiff and the other members of the Class

suffered damages in connection with their respective purchases and sales of the

Company's securities during the Class Period.

V. THE PARTIES

A. The Lead Plaintiff

29. Lead Plaintiff Robert A. Brown, a citizen and resident of Arizona,

purchased and/or acquired NetBank common stock during the Class Period at

artificially inflated prices and was damaged thereby. Attached hereto is a copy ofMr.

Brown's PSLRA certification that was filed previously in this litigation.

B. The Individual Defendants

1. Steven F . Herbert ("Herbert")

30. Defendant Herbert was, from the inception of the Class Period through

October 5, 2006, NetBank's Chief Financial Executive ("CFE") and a Director ofthe

Company. From October 5, 2006 through December 17, 2007, Herbert was replaced

Defendant Freeman as NetBank's Chief Executive Officer ("CEO"). Herbert signed

the Company's Forms 10-K for the years 2004 and 2005. He also signed Company's

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Forms 10-Q for the first, second and third fiscal quarters of 2005 (filed with the SEC

on May 10, August 9 and November 14, 2005, respectively) and Forms 10-Q for the

first and second fiscal quarters of 2006 (filed with the SEC on May 10 and August 8,

2006, respectively). As to each of the Forms 10-K and 10-Q that Herbert signed, as

well as NctBank's Form 10-Q for the third fiscal quarter of 2006 (filed on November

9, 2006 ), he also signed a Certification Pursuant to Rules 13a-14(a) and 15d-14(a)

under the Securities Exchange Act of 1934, as Amended, and a Certification Pursuant

to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 ofthe Sarbanes-Oxley

Act of 2002. Defendant Herbert also signed many ofthe Company's Forms S-K filed

with the SEC and made numerous public statements to the investing public through

various means including, but not limited to, press releases, media interviews and

con Terence calls with analysts and investors.

31. Defendant Herbert made numerous false and misleading

misrepresentations via SEC filings, press releases, and/or similar financial statements

and reports that were disseminated to the investing public. Among other things,

Herbert was responsible for NetBank's improper accounting practices in connection

with its non-conforming mortgage loans, as alleged more fully below. As CFE,

Herbert was responsible, acting under the supervision of defendant Freeman and the

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Audit Committee, for all financial accounting, financial reporting to investors and

regulators and financial statements of NctBank, as well as advising the Board of

Directors and senior management . Accordingly, Herbert possessed superior

knowledge ofand the power to influence and direct the financial accounting, financial

reporting, and financial statements at NetBank. Herbert provided substantial

assistance to, participated in, knew of, and/or recklessly disregarded the facts and

circumstances of the acts and transactions alleged herein.

32. Defendant Herbert joined NetBank in 2002 after the Company acquired

RBMG, where Herbert had served as the CFO prior to the acquisition. Herbert has

extensive experience in the accounting and financial services industry, having served

as the Chief Finance Executive ofRBMG for seven years. Prior to joining RBMG,

Herbert managed the 20-person audit practice of Price Waterhouse, LLP in Columbia,

South Carolina.. He also worked as Assistant Vice President, Manager of Bank

Accounting for South Carolina National Bank.

2. Douglas K. Freeman ("Freeman")

33. Defendant Freeman served as NetBank's CEO from April 1, 2002

through October 5, 2006. He became Chairman of its Board of Directors on January

29, 2003 and resigned that position on October 5, 2006. Like Herbert, Freemanjoined

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NetBank in 2002 after the Company acquired RBMG, where he served as the CEO.

Freeman signed the Company's Forms 10-K for the years 2004 and 2005. He also

signed a Certification Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities

Exchange Act of 1934, as Amended, and a Certification Pursuant to 18 U.S.C.

Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of2002

as to the Company's Forms 10-K for the years 2004 and 2005 and Forms 10-Q for the

first, second and third fiscal quarters of 2005 (filed with the SEC on May 10, August

9 and November 14, 2005, respectively) and Forms I0-Q for the first and second

fiscal quarters of 2006 (filed with the SEC on May 10 and August 8, 2006,

respectively). Defendant Freeman also made numerous public statements to the

investing public through various means including, but not limited to, press releases,

media interviews and conference calls with analysts and investors.

34. Defendant Freeman was responsible for the operations and management

of the Company and possessed the power and authority to control both the Board and

the officers and other executives of NetBank. Accordingly, Freeman possessed the

power to, and did in fact, direct the acts and transactions of the Company and the acts

of its officers and directors , including, but not limited to, the Company's accounting

practices and financial reporting. Defendant Freeman provided substantial assistance

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to, participated in, knew of, and/or recklessly disregarded the facts and circumstances

of the acts and transactions alleged herein. Freeman received a lump-sum payment

of $2.9 million as a severance package when he left NetBank in late 2006.

3. James P. Gross ("Gross")

35. Defendant Gross was appointed to replace Defendant Herbert as

NetBank's Chief Financial Executive ("CFE"), beginning in October 5, 2006, at

which time he was responsible for all financial operations and reporting for the

Company. At the time of his appointment as CFE of NetBank, Gross had served as

the Company's Controller since January 2004. From 2002 to 2004, he served as the

Company's Director of Financial Planning and Reporting . As CFE, Gross signed the

Company's Form 10-Q for the third quarter of 2006. He also signed a Certification

Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of

1934, as Amended, and a Certification Pursuant to 18 U.S.C. Section 1350 as

Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 to the

Company's Form 10-Q for the third quarter of 2006. Defendant Gross also signed

many of the Company' s Forms 8 -K filed with the SEC and made numerous public

statements to the investing public through various means including, but not limited

to, press releases and conference calls with analysts and investors.

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36. As CFE of NetBank , Gross possessed the power to, and did in fact,

control and direct the acts and transactions of NetBank and the acts of NetBank's

officers as they related to the Company's application of accounting methods and

financial reporting of the operations of NetBank. Gross provided substantial

assistance to, participated in, knew of, and/or recklessly disregarded the facts and

circumstances of the acts and transactions regarding NetBank beginning as alleged

herein.

37. Prior to joining NetBank in March 2002, Gross served in this same

capacity at RBMG from 2000 through 2002. Prior to joining RBMG, he held

executive management positions with several mortgage banking companies, including

serving as CFO of IndyMac and J. L Kislak Group. Gross began his career in public

accounting with E&Y, which served as the independent auditors for RBMG and

NetBank.

4. Thomas H. Muller, Jr. ("Muller")

38. Defendant Muller was named Chairman ofNetBank on October 5, 2006,

replacing T. Steven Johnson. He served on the Company's Board and as Chairman

of its Audit Committee since its inception. Muller signed the Company's Forms 10-K

for the years 2004 and 2005.

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39. Defendant Muller has more than 30 years of experience in financial

management. lie is currently president ofMuller & Associates, a business operations

and financial management company. As the former CFO of SpectRx, Inc., he oversaw

that company's financial operations as well as personnel, administrative and legal

activities . His previous experience also includes serving as CFO for HBO &

Company and Coca-Cola USA.

5. Eula L. Adams ("Adams")

40. Defendant Adams served as a Director of NetBank during the period

from July 2003 until his resignation which was effective as of September 28, 2007.

As a Board member, Adams served as a member of the Audit Committee and

Corporate Governance Committee. In his capacity as a Director of NetBank, Adams

signed the Company's Forms 10-K for the years 2004 and 2005.

41. Defendant Adams is the Vice President, Data Management,

Group/Services Delivery, for Sun Microsystems, Inc. He has more than 30 years of

experience in financial services and accounting . Adams has also served as Vice

President, Global Services for StorageTekbefore its acquisition by Sun Microsystems

in August 2005. Previous to that, Adams spent 18 years with Deloitte & Touche

where he became a partner and served in various positions.

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6. David W. Johnson , Jr. "Johnson"

42. Defendant Johnson served as a Director ofNetBank from the Company's

inception in 1996, and also served as a member ofthe Board's Audit Committee until

his resignation from the Board in May 2005. In October 2006, Johnson was elevated

to Vice Chairman of the Company. Johnson signed the Company's Forms 10-K for

the years 2004 and 2005.

43. Defendant Johnson has more than 30 years of experience in mortgage

banking. Johnson served in various capacities with RBMG for eight years, including

chief operating officer, president, chief executive officer, vice chairman and

-managing director. Prior to joining RBMG, he was with Bear, Stearns & Co. Inc. and

with Bankers Mortgage Corporation.

7. Catherine A. Ghiglieri ("Ghiglieri")

44. Defendant Ghiglieri served as a Director of NetBank from December

2003 until she resigned on September 20, 2005. During that period, Ghiglieri served

as a member of the Board's Audit Committee. In her capacity as a Director of

NetBank, Ghiglieri signed the Company's Form 10-K for the years 2004.

45. Defendant Ghiglieri was the president of Ghiglieri & Company, a

management consulting firm she founded in 1999, after an extensive bank regulatory

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career. Ghiglieri served as Texas Banking Commissioner for seven years and was

responsible for the supervision of the third largest state banking system in the United

States. Prior to that, she spent 18 years in various positions of responsibility with the

Office of the Comptroller of the Currency.

46. Defendants Freeman, Gross, Herbert, Muller, Adams, Johnson, and

Ghiglieri are collectively referred to herein as the "Individual Defendants."

47. As a result of their positions with the Company, each of the individual

Defendants had access to the adverse non-public information about the Company's

true financial results, operations and condition, and each had access to internal, non-

public corporate documents, conversations and connections with other corporate

officers and employees, attendance at management and/or Board of Directors'

meetings and committees thereof, and reports and other information provided to them

in connection therewith. Because of their positions with the Company, all of the

Individual Defendants controlled and/or possessed the power and authority to control

the contents of the Company's SEC filings , press releases , and presentations to

securities analysts, through which information was conveyed to the analysts and then

to the investing public. Each of the Individual Defendants was responsible and

obligated to ensure the accuracy of the Company's SEC filings, reports, and press

-26-


releases alleged herein to be misleading , and each had the ability and opportunity to

prevent their issuance if they were inaccurate or to promptly correct same.

48. Because oftheir positions and access to material non-public information

available to them, each of the Individual Defendants either knew or recklessly

disregarded that the Company's SEC filings, press releases, and presentations to

securities analysts contained material misstatements and omissions. Each of the

Individual Defendants is, therefore, liable formaking or participating in making such

material misstatements and omissions regarding the true state of the Company's

financial results, operations and condition.

49. Defendants Muller, Adams, Johnson, and Ghiglieri each served as

members of the Audit Committee of NetBank's Board of Directors at various times


50. The Charter ofthe Audit Committee of the NetBank Board of Directors

stated, in part, that:

The Audit Committee's purpose is to oversee the Company's accounting

and financial reporting processes and the audit of its financial

statements. The Committee shall provide assistance to the corporate

directors in fulfilling their responsibility to the shareholders, potential

shareholders, and investment community relating to corporate

accounting, reporting practices of the corporation, and the quality and

integrity of the financial reports of the corporation. In so doing, it is the

-27-


responsibility of the Audit Committee to maintain free and open means

of communication between the directors, the independent auditors, theinternal auditors, and the financial management of the corporation. The

Audit Committee's performance and composition will at all times be

subject to, and in compliance with: (i) Section 1OA of the Securities

Exchange Act of 1934 and the rules promulgated thereunder; and (ii)

regulations promulgated by any stock exchange upon which the

Company's securities are traded.

51. The Individual Defendants are liable as direct participants in the wrongs

complained ofherein. In addition, the Individual Defendants, by reason oftheir status

as senior executive officers and/or directors, were "controlling persons" within the

meaning of §20(a) of the Exchange Act and had the power and influence to cause the

Company to engage in the unlawful conduct complained of herein. Because of their

positions of control, the Individual Defendants were able to and did, directly or

indirectly, control the conduct of NetBank's business and operations.

VI. OTHER RELEVANT PERSONS AND ENTITIES

A. Ernst & Youn LLP - NetBank' s Independent Auditor

52. Ernst & Young LLP ("E&Y") was, at all relevant times, the outside

accountant and auditor for NetBank. E&Y served as NetBank's independent public

accountants and auditors from 2002, having replaced Deloitte & Touche LLP as the

Company' s auditors . During the Class Period E&Y's NetBank engagement was

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headed by Engagement Partner Konstantin Grobovsky and Senior Auditor Nick.

Seina. E&Y continued to served as NetBank's outside accountant and auditor until.

its resignation on October 10, 2006, when it was eventually replaced by Porter Keadl e

Moore, LLP.

53. E&Y is a "Big 4" public accounting firm with offices throughout the

United States, including Atlanta, Georgia. E&Y was engaged to examine, audit, and

provide opinions on NetBank ' s financial statements for the years 2002, 2003, 2004

and 200 5. Specifically , E&Y audited NetBank's financial statements for, among

others, each of the fiscal years ended December 3 1, 2004 and 2005, issued

unqualified audit reports on those financial statements, and consented to the inclusion

of those unqualified audit reports in E&Y's Forms 10-K for those periods. E&Y's

unqualified audit reports on those financial statements were dated March It, 2005

and March 13, 2006, and addressed to the Board of Directors and Shareholders of

NetBank. However, those reports specifically provided that:

These financial statements are the responsibility of NetBank, Inc.'smanagement . Our responsibility is to express an opinion on thesefinancial statements based on our audits.

-29-


B. Non-Party Directors of NetBank

1. J. Stephen Heard

54. J. Stephen Heard served as a Director of NetBank during the Class

Period. In his capacity as a director of NetBank, Heard signed the Company's Forms

10-K for the years 2004 and 2005. Heard is president of Heard Systems, Inc., a

provider of point-of-use systems and information systems consulting services. Ile

worked for IBM for approximately 30 years and later served as product sales

executive, Vanstar Corporation and area vice president, Hartford Computer Group.

2. Joel A. Smith, III

55. Joel A. Smith, IIi, served as a Director of NetBank during the Class

Period. In his capacity as a director of NetBank, Smith signed the Company's Forms

10-K for the years 2004 and 2005. Smith has over 30 years of experience in banking.

After retiring from Bank of America in 2000, he became Dean of the Moore School

of Business at the University of South Carolina. Smith joined Bank of America in

1971 and eventually served as the president of Bank of America East with

responsibilities for commercial, small business, premier and consumer banking

divisions.

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3. Robin C. Kelton

56. Robin C. Kelton served as a Director of NetBank during the Class

Period. In his capacity as a director ofNetBank, Kelton signed the Company's Forms

10-K for the years 2004 and 2005. Kelton is Chairman and Chief Executive Officer

of Kelton International Ltd., an investment banking firm formed in January 1.996

specializing in the banking and insurance industries. He is founder and former

Chairman and Chief Executive Officer of the Fox-Pitt, Kelton Group and Fox-Pitt,

Kelton, Inc. In addition, he is Chairman of Thomas Murray Limited, a financial

services company, Chairman ofFindlay Park Investment Management Ltd. and Eagle

& Dominion Asset Management Ltd., both fund management companies, and

executive Chairman ofFinancial Centre Corporation, the St. Lucia offshore financial

centre.

4. Stuart M. Cable

57. Stuart M. Cable served as a Director ofNetBank during the Class Period.

In his capacity as a director ofNetBank, Cable signed the Company's Forms 10-K for

the years 2004 and 2005. Cable is an attorney with Goodwin Procter LLP. He served

as a director of Resource Bancshares Mortgage Group, Inc. ("RBMG") from 1992

until its merger with NetBank on March 31, 2002, at which time he became a director

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of the Company.

5. Tamara L. Adler

58. Tamara L. Alder Lundgren served as a Director of NetBank throughout

the Class Period, beginning in December 2003. In her capacity as a director of

NetBank, Lundgren signed the Company's Forms 10-K for the years 2004 and 2005.

Adler is a senior finance professional and lawyer with more than 20 years of

structured finance, corporate and real estate experience. She also served as the

managing director and head of the Structured Finance group within Debt Capital

Markets at JP Morgan Chase. Prior to joining JP Morgan, she served as the managing

director and head of Deutsche Bank's European Securitization Group where she was

also a member of Deutsche Bank's Global Markets Management Committee. Adler

was also a partner at Hogan & Hartson, LLP in Washington, D.C.

6. T. Stephen Johnson

59. T. Stephen Johnson served as the Chairman of NetBank's Board from

the Company' s inception through early 2003 and, thereafter, continued to serve on

the Company's Board through the Class Period. In his capacity as a director of

NetBank, Johnson signed the Company's Forms 10-K for the years 2004 and 2005.

Johnson was President of Johnson & Associates ("TSJ&A"), a bank consulting firm

-32-


located in Alpharetta, Georgia. The firm specialized in mergers, acquisitions and

regulatory consulting . TSJ&A has served as advisor and consultant in the formation

of approximately 70 banks in the southeastern United States. Mr. Johnson served in

a management capacity for two large Atlanta banks before forming TSJ&A in 1987.

Mr. Johnson also serves as Vice Chairman of Florida Banks, Inc., a bank holding

company, Chairman of Direct Payment Technologies, Inc., a card payment and

processing company, and Chairman of Brightlane.com, Inc., a business-to-business

portal. In addition, he is principal owner of Bank Assets Inc., a provider of benefit

programs for directors and officers ofbanks, and TSJ Advisory Group, an investment

advisory company.

VU. CLASS ACTION ALLEGATIONS

60. Plaintiff brings this action individually and as a class action pursuant to

Rule 23(a) and 23(b)(3) of the Federal Rules of Civil Procedure on behalf all persons

who, during the Class Period, March 16, 2005 through and including May 21, 2007,

purchased or otherwise acquired any securities publicly issued by NetBank, Inc.,

including without limitation NetBank common stock, and held such securities as of

May 21, 2007, and where damaged thereby (the "Class"). Excluded from the Class

are the Defendants herein, members of the Individual Defendants' immediate

-33-


families, any entity in which any of the Defendants has or had a controlling interest,

any person or entity affiliated with any of the Defendants, and the legal

representatives, heirs, successors or assigns of any of the Defendants.

61. This action is properly maintainable as a class action because:

(a) The Class is so numerous that joinder of all members is

impracticable. According to the Company's Form 10-K for year ended 2005, as filed

with the SEC on March 15, 2006, NetBank had 46,586,415 shares of its common

stock issued and outstanding as of March 6, 2006. During the Class Period,

NetBank's common stock was listed and actively traded on the NASDAQ, a national

securities exchange and an efficient market, and a liquid market for NetBank common

stock. While the exact number of Class members is presently unknown and can only

be ascertained through appropriate discovery, Plaintiff believes that there are many

hundreds, possibly thousands, ofClass members located throughout the United States

who similarly purchased or otherwise acquired NetBank securities during the Class

Period.

(b) Plaintiff's claims are typical of the claims of the other members

ofthe Class. Plaintiff and the other members ofthe Class have sustained damages that

arise from, and were caused by, Defendants' wrongful acts alleged herein. Plaintiff

-34-


does not have interests antagonistic to, or in conflict with, the other members of the

Class;

(c) Plaintiff is a representative party who will fairly and adequately

protect the interests of the other members of the Class and has retained counsel

competent and experienced in class action securities litigation;

(d) A class action is superior to other available methods for the fair

and efficient adjudication of the claims asserted herein, because joinder of all

members is impracticable. Furthermore, because the damages suffered by individual

Class members may be relatively small, the expense and burden of individual

litigation make it virtually impossible for Class members to individually redress the

wrongs done to them. The likelihood of individual Class members prosecuting

separate claims is remote;

(e) Plaintiff anticipates no unusual difficulties in the management of

this action as a class action; and

(f) Common questions of law and fact predominate over any

questions affecting any individual members of the Class.

62. Among the common questions of law and fact are:

(a) Whether the federal securities laws were violated by Defendants'

-35-


acts and omissions as alleged herein;

(b) Whether the documents , press releases, financial reports and

statements disseminated by the Defendants to the investing public during the Class

Period misrepresented or omitted material facts about the financial results, operations

and condition of NetBank.;

(c) Whether NetBank's publicly disseminated financial statements

and reports were materially false and misleading as alleged herein;

(d) Whether Defendants acted with knowledge or with sufficient

reckless disregard for the truth in misrepresenting and/or omitting to state material

facts;

(e) Whether, during the Class Period, the market price of Net 3ank's

common stock was artificially inflated due to the omissions and/or material

misrepresentations complained of herein;

(t) Whether Defendants participated in and. pursued the common

course of conduct complained of herein;

(g) Whether the Individual Defendants were "control persons" within

the meaning of Section 20(a) of the Exchange Act; and

(h) Whether the members of the Class have sustained damages and,

-36-


if so, what is the extent of such damages.

VIII. ADDITIONAL SUBSTANTIVE ALLEGATIONS

A. Corporate History of NetBank

63. NetBank was founded in October 1996 when it received its federal

banking charter. That same month, NetBank completed its initial public offering of

stock for $12 a share, under the name NetB@a nk Inc. At the time, the Company

claimed its operating expenses were half those of a traditional "bricks-and-mortar"

hank, and that it could thus offer customers higher rates on checking accounts and

certificates of deposit. When the Company began its Internet banking operations,

NetBank was one of the pioneers of the Internet banking industry, and its subsidiary,

NetBank., FSB, was recognized as one of the first successful internet-only banks. At

that time, NctBank's touted value proposition and product line was differentiated in

the marketplace, since few direct competitors existed. The Company claimed that its

products and services were designed to serve a growing base of computer-savvy

consumers who were seeking both convenience and greater economic value.

64. Over time, NetBank essentially evolved into a financial holding

company, but claimed it was still engaged primarily in retail banking. NetBank's

additional business segments grew to include mortgage banking, business finance,

-37-


insurance and providing ATM and merchant processing services . See generally

Section IV, supra.

B. NetBank' s Business Segments

65. Prior to its demise in 2007, Netbank's business consisted primarily of

three segments: retail banking, transaction processing, and services as a financial

intermediary.

66. Retail Banking. Retail banking was NetBank's core business segment

from its inception . As the Company' s operations expanded into transaction

processing and financial intermediary services, NetBank insisted that retail banking

would remain its core business. NetBank's retail banking segment was comprised of

personal and small business banking operations, an automobile financing unit and a

business financing unit. NetBank, FSB, through its Internet banking operations,

operated as an Federal Deposit Insurance Corporation ("FDIC ") insured, federally

chartered thrift institution. NetBank, FSB offered a full line of deposit and loan

products, including checking and savings accounts, a small business banking

program, online bill payment, auto loans, and financial planning services. As such,

NetBank, FSB served approximately 285,669 customers throughout the United States

and in more than 90 foreign countries. NetBank, FSB delivered its products and

-_8-


services through remote delivery channels, such as the Internet, telephone and ATMs,

that were available 24 hours a day and seven days a week. NetBank, FSB did not

maintain a branch network to support its banking business. This branchless model

provided it with an opportunity to operate with less overhead expense than traditional

branch banks; however, it also presented numerous challenges not faced by traditional

branch based banks. Indeed, passing along part of the potential cost savings to

customers through higher deposit rates and better technology had been the

cornerstone of NetBank's supposed value proposition.

67. Transaction Processing . The transaction processing segment included

NetBank's ATM and merchant processing business, mortgage servicing division and

a number of start-up operations that delivered banking or item clearing functionality

to other financial institutions or merchants. NetBank established this segment in 2003

when it began restructuring the Company in attempting to leverage many ofthe core

business competencies in its retail banking and financial intermediary segments, and

market them on a business-to-business basis. Those action were supposed to provide

the Company with additional revenue generating opportunities from then existing

business activity. This shift in focus was motivated by the fact that NetBank's core

banking business was not as strong as it had been portrayed, and the viability of

-39-


NetBank's business over the long-term was at particular risk if the Company did not

seek and obtain additional sources of revenue outside of its core banking business.

Through its transaction processing segment, NetBank had also been an active acquirer

of small, profitable processing businesses that, when properly executed, should have

supposedly complemented its overall business strategy. For example, in late 2003,

NetBank acquired an ATM and merchant transaction processing operation , including

the subsidiary known as FTY. During 2004 and 2005, the ATM and merchant

transaction processing operation grew through acquisitions and internal growth. At

its height, the business operated at least 9,649 ATMs across the United States. At the

time, NetBank ' s network ofATMs ranked as the second largest bank-operated ATM.

network in the country.

68. Financial Intermediary . The financial intermediary segment included

NetBank's mortgage and specialty lending operations. Through the segment's various

loan operations, NetBank served as an intermediary between consumers and

institutional investors. The Company diversified its operations through acquisition

to include the origination of loans for recreational vehicles (RVs), boats and personal

aircraft . The Company earned fees on the loans it originated and had the opportunity

to earn a profit on the sale ofthe mortgage loans or mortgage backed securities which

-40-


consisted of portfolios of multiple loans packaged into an investment vehicle. The

loans were either retained by the retail banking segment to meet the Bank's

investment needs or sold to investors in the capital markets under the same

intermediary strategy the Company employed in its mortgage businesses. The bulk

of the business in this segment related to mortgage lending, and included both so-

called conforming and non-conforming products.

C. Overview of Bank Mortgage Lending

69. Mortgage loans fall into two broad categories: conforming and non-

conforming.

70. Conforming Mortgage Loans: Conforming mortgages are mortgages

that have terms and conditions that follow the guidelines and standards set forth by

the Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan

Mortgage Corporation ("Freddie Mac"), two stockholder-owned corporations. Fannie

Mae and Freddie Mac guidelines establish the maximum loan amount, borrower

credit and income requirements, down payment, and suitable properties. Fannie Mae

and Freddie Mac announce new loan limits every year. Fannie Mae and Freddie Mac

also purchase mortgage loans that conform with. their guidelines from mortgage

lending institutions, such as NetBank. Once purchased, these conforming mortgages

-41-


are then typically packaged into securities and sold to investors. Because these

"conforming" mortgages must comply with Fannie Mae and Freddie Mac guidelines,

they are understood to be safer investments that involve less risk than non-

conforming mortgages. Through this process, Fannie Mae and Freddie Mac, like the

Government National Mortgage Association ("Ginnie Mae"), provide a continuous

flow of affordable funds for home financing that results in the availability of

mortgage credit for American home buyers.

71. Non-Conforming Loans : A nonconforming mortgage is a loan that

fails to meet certain bank criteria for funding. Such a loan may fail to conform to the

bank's lending criteria because, for example, the loan amount is higher than the

conforming loan limit. A substantial portion of real-estate loans are qualified as non-

conforming because either the borrower's financial status or the property type does

not meet bank guidelines. Non-conforming loans can be either A-rated paper (less

risky) or subprirne loans (more risky). Subprime lending carries increased risk for

both lenders and borrowers due to the combination of high interest rates, poor

borrower credit history, and the questionable financial circumstances often associated

with subprime applicants. Due to the increased risk, subprime loans are offered at an

interest rate higher than A-paper loans.

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72. Mortgage originators "package" large volumes ofhome loans to be used

as collateral in massive mortgage-backed security ("MBS") offerings (also known as

collateralized debt obligations or CDOs) to investors such as ledge funds, allowing

the originators to further finance their activities.

73. During the course of the 1990s and early 2000s, as the housing market

in the United States increased substantially in strength, many lending institutions

were willing to provide mortgages to low credit high risk borrowers relying on the

increased value of the housing markets to provide protection against default. These

mortgages were then packaged for sale to investors.

74. In early 2006, as the housing market began to weaken, two trends in the

secondary market for subprime mortgages emerged: (1) sales of home equity loans

for borrowers with the weakest credit and the smallest cash down payments produced

sizable discounts as investors took into account the end of rapid home price

appreciation as a safety net for such borrowers, as well as other credit concerns;

however, lender pricing did not take these into account; and (2) forced repurchases

of subprime loans experiencing delinquencies early in their lives began to rise. Such

forced repurchases, reflect both a spike in "early payment defaults" and more

aggressive enforcement of related contractual clauses by the investors, especially

-43-


Wall Street conduits.

IX. DEFENDANTS' ADDITIONAL FALSEAND MISLEADING STATEMENTS

A. NetBank's Surreptitious Transition From Its Core Banking

Operations to the Subprime Mortgage Market

75. From its founding in 1996 to 2001, NetBank had grown to become the

Country's largest retail Internet bank. During that period, NetBank went from

approximately 5,000 accounts with $100 million in deposits in 1996, to 245,000

accounts with $1,5 billion in deposits and $2.9 billion in assets as of December 31,

2001.

76. Beginning at least as early as 2000, NetBank faced two separate

problems. First, although new account growth allegedly remained robust, NetBank

knew that the base ofdepositors the Company relied upon to grow would soon mature

and, as a result, growth would then stagnate . Until that time, NetBank's business

model had been fueled solely by such rapid depositor growth in its core banking

sector. Second, NetBank knew that its new deposit accounts were substantially and

incrementally less profitable to NetBank than its mature accounts. Thus, even if

NetBank could continue to rapidly grow its base of depositors, doing so would prove

to be a significant drain on the bank's resources and severely hamper profitability --

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a fatal flaw to its basic growth strategy.

77. In an attempt to address these inherent problems with the Company's

business model, NetBank focused its efforts on two areas: (1) developing banking

products and services aimed at retaining customers, thereby fostering its more

profitable mature customer base, while seeking to actually slow the growth of new

accounts; and (2) shifting the Company's founding strategy away from its core

banking segment in order to develop other business segments that would leverage its

core banking assets. In making this shift, NetBank set about to begin acquiring one

or more mortgage companies.

78. On June 29, 2001, NetBank acquired Market Street Mortgage

Corporation ("Market Street"). Market Street was a retail mortgage lender based in

Clearwater, Florida, which primarily originated fixed first mortgages. In doing so,

NetBank made an initi al effort to concentrate on investing in singl e-fam ily residential

loans with adjustable rates to manage the interest rate risks. The past due rates on

these types of mortgages were approximately one-tenth the industry average which

fit the conservative strategy NetBank had pursued up until that time. The Market

Street acquisition enabled NetBank to originate over $3 billion in loans annually.

Market Street contributed positively to NetBank's earnings immediately following

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the first quarter after the acquisition, which appeared to validate the Company's new

strategy.

79. In the NetBank's 2001 Form 10-K, filed with the SEC on March 18,

2002, the Company reported the alleged success of its Market Street acquisition as

follows:

We also diversified and enhanced our income stream through the

acquisition ofMarket Street. This acquisition allowed us to generate fee

income related to the origination and sale of first mortgages, to reduce

the risk of material write-downs of premiums related to prepayment

activity during periods of declining rates, and to participate in the

increased refinancing activity during a period of declining rates.

80. However, in order for NetBank to generate the revenue sought, it was

necessary For the Company to significantly increase its mortgage-lending capabilities.

Buoyed by the apparent success o (the Market Street acquisition, NetBank continued

its expansion into the mortgage market through the 2002 acquisition of RBMG, a

wholesale mortgage banking company headquartered in Columbia, South Carolina.

RBMG had a nationwide network ofcorrespondents and brokers, and generated close

to $12 billion in mortgages annually. However, the RBMG acquisition included the

acquisition of RBMG's subsidiary known as Meri.tage , a subprime lender.

81. As alleged above, defendants Herbert and Freeman were, respectively,

-46-


the CF() and CEO, of Meritage. As a result of NetBank's acquisition of RBMG,

Herbert became the CFF of NetBank and Freeman replaced D.R. Grimes as the

Company's CFO. Thereafter, under the direction and control of defendants Herbert

and Freeman and the Company's Board ofDirectors, NetBank surreptitiously shifted

focus from the primarily conservative conforming loans ofMarket Street and RBMG

to Meritage's highly risky subprime loans.

82. NetBank's 2002 acquisition of RBMG and, in particular, its Meritage

subsidiary , represented a crossroads for the Company's history because it ushered in

a new era for the Company during which NetBank was transformed from an Internet

based retail bank, to a financial intermediary to, ultimately, little more than a

mortgage bank with a significant presence in the subprime market.

83. Prior to the RBMG acquisition in 2001, NetBank had little, if any,

exposure to the non-conforming mortgage market. In its 2001 Annual Report,

NetBank claimed that the RBMG acquisition "dramatically expands the company's

lending ability." In the same Report, NetBank went on to state:

NetBank's efficient deposit gathering will provide Market Street

Mortgage and RBMG a lower cost source of funds for loans. With the

acquisition of RBMG and Market Street Mortgage, NetBank will

produce more earning assets than core deposits. We will sell the

majority of our loans into the secondary market, and these assets will

-47-


remain on our balance sheet only for the amount of time that it takes tosell them.

84. Despite N"etBank.'s continuing evolution from an Internet based bank to

a subprime mortgage company, the Defendants attempted to deceive the investing

public into believing that it was not a significant subprime lender. For example, on

August 3, 2005, defendants Herbert and Freeman engaged in the following colloquy

with an analyst (emphasis added):

ANNETTE FRANKIE, ANALYST, FRIEDMAN BILLINGS

RAMSEY: *' ** And also, I wanted to ask on the sub-prime

originations , how deep do you go into the cycle spectrum on the sub-

prime loans?

STEVE HERBERT: Okay. Well, on the sales versus production side,

there is nothing unusual there. The volume of production did exceed

sales, so we created more value and it was released into the income

statement in the current quarter. That is just normal timing in periods in

which volumes tend to accelerate, sales tend to lag because of the 30-

day delay on sales. If you looked at production for April-or March,

April, and May, generally I think you'd find that probably lines up fairly

well with the level of sales that we did in the second quarter because

there's basically a 30-day warehouse lag built into the process. Nothing

peculiar going on. Our sub-prime originations, I have to get you the

distribution of our FICO scores. It is fairly tight.

We do not do anything that you would call C and D type lending. Ingeneral, it's a fairly tight distribution of FICO scores, right around the640-average level. We do have some very high FICO scores in there iswell for some customers that just do not want to do all the paperworkand want to buy big house that does not meet Freddie or Fannie

-48-


guidelines. But I think you are going to find a tight cycle band around

64() that we will be able to show you.

DOUG FREEMAN: Annette, this is Doug. We really don't look like a

subprin,te lender. We call it non-conformingfor° a good reason, that we

look a lot closure [sic l to a confirming loan than we look to some afthe

sections lenders out there.

1. Operational Shortcomings

85. In order to decrease the risk of default relating to subprirne non-

conforming mortgages (as well as, in fact, conforming mortgages), it is critical that

the lender institute a strong set of internal controls to accurately assess the credit

worthiness of each borrower . This is critically important as defendant Freeman

admitted to the Atlanta Journal and Constitution on July 27, 2006, during the Class

Period, because even if non-conforming loans are not bad, "investors who buy the

loans will sell them back if any discrepancy or misrepresentation [by the borrower]

is later found in documents associated with those loans."

86. Indeed, NetBank claimed to have just such a set of strong internal

controls to reduce the risk inherent for its own "non-conforming" loan business. For

example, in its Annual Report for the year 2000, NetBank claimed:

The discipline NetBank has in managing assets is second to none. Webring a scientific and mathematical approach to our process. Everything

-49-


is quantified, including all aspects of loan and customer performance, aswell as pricing and risk implications. We have developed best-executionmodels to enable us to optimize our delivery into the secondary markets.

In each phase of this cycle, we rely on rigorous analytics to determine

the optimal conditions for selling a loan so that we can manage our risk

appropriately while obtaining the highest value possible for our

shareholders.

87. Thereafter, and throughout the Class Period, Defendants continued to

claim that NetBank maintained strong internal controls to reduce the risk associated

with its loan business. For example, in the Company's Form 10-K for the year ended

2005, Defendants stated:

We have a quality control program to monitor compliance with our

established lending and servicing policies and procedures, as well as

with applicable laws and regulatory guidelines. We believe that the

implementation and enforcement of our comprehensive underwriting

criteria and quality control program are significant elements in our

efforts to purchase high-quality mortgage loans and servicing rights. Our

quality control department examines loans in order to evaluate the loan

purchasing function for compliance with underwriting criteria. The

quality control department also reviews loan applications for compliance

with federal and state lending standards, which may involve re-verifying

employment and bank information and obtaining separate credit reports

and property appraisals.

88. Ultimately, such assurances were exposed to be false. Indeed, in closing

down NetBank's operations on September 28, 2007, the federal Office of Thrift

-50-


Supervision issued a press release that specifically attributed NetBank's demise in

part to "weak underwriting", "poor documentation" and "a lack of proper controls".

89. In addition , NetBank 's "branchless" bank model, while innovative, was

not without its limitations. One of the most significant disadvantages facing

depositors of on-line only banks such as NetBank revolves around physical deposits

and withdrawals and ATMs. Since, initially, NetBank had no ATM machines and

never had branches, customers had to rely upon the United States Postal Service to

deposit checks and had no means to deposit hard currency. Similarly, account holders

could not cash checks or withdraw cash at branches. Rather, in order for a NetBank

account holder to obtain their funds in cash, they were required to use an Automatic

Teller Machine ("ATM"). However, because initially NetBank did not own or operate

a network of ATMs, NetBank account holders were forced to use ATMs operated by

competing banks and, in most cases , to pay a fee to do so. Additional downsides

included deposits that could be lost, damaged or delayed in the mail and could not be

tracked without the sender purchasing expensive mail tracking services.

90. The invention of deposit-taking ATMs coupled with NetBank's

acquisition of a large network of ATMs alleviated some of the limitations of

NetBank's actual and prospective account holders because they could make deposits

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in a local ATM, where their check would post and clear very quickly. However, the

widespread nature ofNetBank's customers made it difficult to have ATMs that were

convenient for all customers and many were still required to use mail-in deposits.

91. NetBank attempted to alleviate the cumbersome and potentially risky

issue of making physical deposits by creating QuickPost, a service whereby a

customer drops a deposit off at a UPS Store location to be shipped overnight to

NetBank. The concept underlying QuickPost was that one shipment could contain

deposits from several customers, justifying the additional expense of overnight

shipping. However, the product did not take off, and NetBank was forced to shut

down this operation in 2006.

92. NetBank heralded the development of QuickPost in its Annual Report

for the year 2004, fled with the SEC March 16, 2005 , stating:

For consumers, small business owners and institutions that use

NetBank's transaction processing services, our goal is to offer the most

needed products and services in the most convenient and versatile

setting. To deliver these effectively, we implemented a new online

platform and opened a state-of-the-art payment processing center that

positioned NetBank to take immediate advantage of legislation

authorizing the use of electronic check images. The new processing

center also made it possible for NetBank to develop QuickPostSM, a

service that allows customers to drop off deposits and payments at

approximately 3,800 locations of The UPS Store® for overnight

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delivery and next-day processing.

QuickPost is a service designed to dramatically reduce the time from

check drop-off to availability of funds. Through our agreement with

UPS, a customer can take a deposit or mortgage payment to one of

approximately 3,800 The UPS Store® locations for free overnight

shipment to our payment processing center. Customers receive an e-mail

acknowledgment when the deposit is received the following business

day. This service provides customers greater convenience, security and

quicker access to funds.

Initially piloted in Atlanta, Chicago, New York, Oakland and San

Francisco, QuickPost is now available to all. NetBank customers.

QuickPost represents one more way NetBank is branching out with

innovative services.

93. According to a confidential witness, who was a NetBank officer

employed in the Corporate Finance Department throughout the Class Period and who

had direct dealings with top management including CFE Herbert, NetBank was aware

that QuickPost was an -unsustainable initiative . After implementing QuickPost,

NetBank determined that there were an average of 1.2 deposit items in each envelope

they received, and the cost to NetBank for each envelope sent in was between $11.00

and $1.5.00. Therefore, the cost of QuickPost to NetBank far exceeded the

incremental value of the deposits and further eroded the limited profits that the

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Company earned from depositors while creating an expectation on their part that

NetBank could not readily eliminate without risking further erosion of its depositor

base.

94. During NetBank's August 3, 2005 conference call with analysts and

investors, relating to the second quarter of 2005, the Defendants repeatedly touted

Quick Post:

We are actively promoting an array of services to other financialinstitutions, chiefamong them being Quick Post, our deposit-forwardingservices through the UPS stores. A lot of interest has been expressed inthis service. Our own Net Bank customers have adopted it in droves.During the second quarter, more than a third ofour paper check depositscame in through it.

MATTHEW SHEPHERD : Let me hit the UPS. And I'll let Steve talkabout the seasonality and some entries on the servicing side that I thinkgot us above $ 100 million , probably in the fourth quarter i f I'm notmistaken . Ifyou look at the UPS stuff, Rich , we are extremely bullish onthat . Our customers have already used 90% of the UPS stores to sendpaper checks in to our image Check 21 factory . And the system isworking unbelievably well . Our customer feedback has been outstandingin the process . As we've said publicly, we are very close to announcingother people who have the same transportation-- paper transportationcustomer service funds distribution issues that we are , that they arenational institutions that lack national bricks and mortar. So they'reforced to use our good of postal service or whatever to get theirpayments and checks in to their company. And they have a great interestin coming on the system . So what you will see is, at some point, whenwe have added a third party to our mix, we will break Quick Post out in

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our numbers and that to you and show you metrics that will be able to

get you there. I cannot tell you, Rich, what quarter that will be, because

it needs to be material when we break it out. But I feel extremely good

that you're going to see some very attractive announcements that are

going to move us in that direction.

MARK SPROULE: Just to shift gears-- thank you for the questions-- on

the banking side, you'd mentioned, I think in an earlier question, your

continued focus and ability to drive double-digit asset growth and then

continue small-business customers. flow are you going about right now

attracting those, I mean because we see it on the monthly statistics, you

are not seeing significant ramp up monthly as you go, ofnew customers

there. Are you using rates as your driving force? Or is the QuickPost,

PowerPost type appeal really the method to act the new customers in

and what kind of attraction you are getting? Thanks.

DOUG FREEMAN: The market today, because of our company, we

don't have the earning assets that allow us to be purely a rate play. And

as a matter of fact, that's never been in our strategy. If somebody wants

the hot money, hot, hot, hot money, money market only type of things,

they can probably get a better rate from someone who has got some sort

of match-to-earning asset that they can deploy that against. And today,

we do not have that. So we are extremely competitive from a rate

perspective. But we focus on value. So, if you're a retail customer, it's

the quality of our technology, it's things like QuickPost and all of that

if you're a small business. It's a plethora of services that we offer from

convenience to actually on the phone business bankers to work with

these people. We have online payroll, we have QuickPost, we have

PowerPost and it could go on and on and on. So our strategy has always

been to be a super regional bank in terms of how we approach the

business, but our region is the Internet. If that make sense to you.

95. In its Form 10-Q for the period ending September 30, 2005, NetBank

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reported that, "Expenses increased primarily as the result of increase in marketing

costs related to specific promotions and on-line advertising campaigns that occurred

during the third quarter of 2005, expansion ofDealer Financial Services' operations,

and the roll-out in 2005 of QuickPost, which provides a more convenient way for

customers to make deposits to their NetBank accounts."

96. During NetBank's conference call with investors for the period relating

to the third quarter of 2005, Quick Post was repeatedly touted despite its continuing

drag on earnings because, although many customers had utilized the service, it was

costing NetBank more money to make the service available than the retained

customers were generating for the bank:

The feedback we continue to receive from our own customers aboutQuick Post is overwhelmingly positive. They see it as a very convenient,highly secure method of making deposits and payments.

We continue to view Quick Post as one of the keys to our transactionprocessing revenue growth. USAA and other partners have the potentialto generate significant fee income for us, over time, if their customersadopt this channel to the extent that ours have. Steve will give you moredetail on the various points in his review ofour performance by businessline in a minute.

As a whole, today our company's fundamentals are strong. We have asolid capital position with an attractive base of customer deposit

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relationships. We also benefit from our varied lending operations and

the high potential transaction process and initiatives we have underway.

The work we're doing on that front with Quick Post and Power Post

continue to show great promise. Through relentless execution of our

game plan, we will continue to provide superior service to our chosen

customer segments and prove the company's core earnings profile and,

most importantly, create better value for our shareholders.

JENNIFER DEMBA: Doug, can you give us some sense of what the

penetration and the usage is like for the Quick Post right now from your

customer base?

DOUG FREEMAN: About 90% of the UPS stores are now in the

business ofaccepting loan payments or deposits and forwarding them to

us. So that's unbelievable penetration on the UPS store side. If you look

at our customers, what you see is that if you take out direct deposit of

payroll, about 30% ofthe deposits that we get today are coming through

Quick Post, and we expect that number, actually, to go up, over time, as

we continue our marketing efforts.

97. In its 2005 Form 1.0-K, NetBank reported that "[n]on-interest expense

also increased due to the implementation of the QuickPost initiative as well as

increases in software maintenance expense ." The Company also reported that

"improvements in earnings were offset, in part, by increases in operating expenses of

some $8.735 million, primarily relating to the growth in our auto lending and leasing

operations, as well as the introduction of our QuickPost initiative."

98. In its Form 10-Q for the period ending March 31, 2006, NetBank

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reported that "operating expenses increased by $2.594 million primarily due to

increases in expenses related to our QuickPost initiative."


to the forth quarter of 2005, Quick Post was repeatedly touted:

A - Steven Herbert

And second thing you asked about, quick post, quick post continues togo very well....

A - Steven Herbert

So ifyou remember what our model is, we have the super regional bank

model, which is full service financial institution with the exception and

our region is the internet, which has to say that we offer the second

largest bank, ATM network to our customers, we offer quick post which

actually gives them better, convenience for making deposits or

payments, and better funds availability, than most of the large banks, so

we don't intend to be a product player, we intend to be a distribution can

do it player, which says to me that full service financial institution,

delivered over the internet to a highly targeted group of customers.

Q - Mark Sproule

Got you, and then with the transaction servicing side I mean how do you

look at building that out of - is the return on building the kind of ATM

network cost effective or is it more beneficial to your branding effort

especially given sort of quick post build outs etc?

A - Steven Herbert

Well its, taste great analystfilling, it is absolutely a cornerstone ofourubiquitous convenience value proposition to our bank customers and

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secondarily the way we run the ATM business to remind you we ownless than 5% of the ATMs so its not capital dependent on us to be ableto do this. So it's a situation where at large mega bank as it cost downso much per year to provide ATM access to the customers, in my caseT make so much year by providing ATM access to my customers, sowhen your $5 billion bank you have to be smarter than the average bearand we re-engineered the ATM business value proposition from anoutflow to an inflow. We would expect Quick Post to overtime be thesame thing, we now have unprecedented convenience to our customerswho need a place to make a deposit or make a payment, we granted thatquick post so we could sell that to other banks customers like USAA andothers who will come into that system we believe overtime and create aproposition again when we provide unprecedented ubiquitousconvenience to our customers and make money on that channel at thesame time.


to the first quarter of 2006, the Defendants continued to tout the prospects for Quick

Post despite their knowledge that the initiative was failing:

Our main areas of focus in the coming months will be three fold...andnumber three, move quick post towards profitability by leveragingcurrent partnerships and pursuing new ones.

^^xx

A - Steven Herbert

That's correct, Mike. The Retail Bank did show some loss, whileNetBank Business Finance had a better quarter on somewhat highervolumes, really drove that, and somewhat reduced the moderatingprovision loans for the bank standing alone. Retail Bank standing alonereported a $1.4 million loss. A good bit ofthat or actually the vastmajority of that relates to, at least in part, to the investment that we

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continue to make in the QuickPost product.

A - Douglas Freeman

And the issue in here will be QuickPost and PowerPost, and those arcthe strategic initiatives as we move forward managing through that.


to the second quarter of 2006, the Defendants stated:

As we explained in the press release, the primary driver to QuickPost

expenses is the number of UPS stores sending packages in each day.

About two-thirds of the stores are now generating packages on a daily

basis. The cost for these packages remains the same, whether there is

one deposit in a package or 20. The key is now to increase the number

of deposits or payments contained in the packages.

The headline really inside the retail bank is the QuickPost, PowerPost

and NetServe expenses which we pulled out to enhance people's ability

to sort of see the numbers, or this additional detail, I think, adds some

color to what's really going on there. That operation has a heavy initial

marginal fixed cost structure, so those marginal fixed costs are

frontloaded as volumes come on board. So we've seen a significant

uptick in the expense structure, and that's what accounts for the increase

that we've seen in the next expense from QuickPost, PowerPost and

NetServe as we continue to make an investment in those initiatives.

The retail bank, excluding the Quick-Post, PowerPost and NetServe

initiatives posted about a $1.6 mill ion operating profit after taking out

the HELOC gain on sale and overall, obviously, we got leverage long-

tenn and a flat yield curve that's going to probably slowly grind against

those numbers or work against improving it, so we're slightly negative

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on the outcome that we would probably see there after adjusting.

QuickPost, PowerPost, NetServe, most of the fixed costs are probably

in the numbers that you're looking at in the current quarter. They

probably will get a little bit worse before it gets better. We are, I guess,

optimistic that it won't get too much worse before wve get to the volume

levels that will start to result and it'll move back towards breakeven or

profitability for those investments.

Q- Hi, guys. Yes. Daniel Hayes in for Mark Sproule. Is there any way

for you to quantify the benefit of the QuickPost contribution - sorry if

you've already mentioned this -- to earrings growth, to the earnings

asset growth, and maybe quantify more of the expenses surrounding

QuickPost?

A - Doug Freeman

Yeah, I think - this is Doug, Daniel. We have started to breakout the

expense stream so that you all can start getting a handle on the expenses

associated with it. Secondarily, a couple of months ago we began to

break out QuickPost volume back 12 months historically. So with that

being said, at some point in time you all are going to be able to get your

hands around the marginal costs, marginal revenue associated with that.

But as of today, the only metrics that we give you are the total expenses

and then the volume.

M. During NetBank's conference call with investors for the period relating

to the third quarter of 2006, Defendants stated:

We have made the hard decision that we had to make with respect toQuickPost and FTI and we are in process of exiting that business andexpect it to be completed by the end of the year, check it off the list.

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In the second quarter, the retail bank earned $1.8 million, ifyou excludethe QuickPost expenses and take out the gain on sales of HFLOC.


to the third quarter of 2006, NetBank reported that "we were still in our QuickPost

operation losing S3 million a quarter , trying to prepare for a future far off into the

distance."

2. Failed ATM network and Check Clearing Business

104. According to a confidential witness, who was a senior executive officer

of NetBank during most of the Class Period, and who had direct daily contact with

the top executive officers, the Company's network of ATMs was an integral part of

NetBank's Internet banking model, but never gained acceptance with customers.

Despite Defendants ' knowledge that NetBank 's ATM network and related Check

Clearing business were failing, the Company continued to allocate capital to them

because in the face of mounting subprime losses NetBank could ill afford to risk

eroding its depositor base if it abandoned its ATM network.

105. According to a confidential witness, who was a senior corporate officer

of NetBank during most of the Class Period, and who provided input directly to

defendants Freeman, Herbert, and Gross, the ATM business purchased by NetBank

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was the 2" largest network in the U.S. However, the Defendants knew that the

network of ATMs was located in non-strategic locations that made it ineffective for

the purpose of generating sufficient acceptance and use by NetBank's depositor

customers.

106. According to a confidential witness, who was a senior executive of

NetBank during the entire Class Period, and who had regular daily interaction with

defendants Freeman, Herbert and Gross, the Defendants knew that Quick Post and

NetBank's ATMs were flawed initiatives.

3. Warehouse Line of Credit

107. NetBank and Meritage maintained a warehouse line of credit which was

essential to the continued operation of the Company' s mortgage business . Meritage

used and relied upon that line of credit to make subprime loans and could not have

generated the level ofsubprime mortgage loans that it did during the Class Period had

it not been for Meritage's reliance upon the line of credit.

108. A warehouse line of credit ("WH") is a revolving debt facility or line

of credit in which a mortgage banker, such as Meritage, arranges for a loan from a

warehouse lender. The original note from the loan is then kept by the warehouse

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lender while the remainder of the documents go to the mortgage banker, who then

offers it for sale. When an investor purchases the loan, the warehouse lender gives the

original note to the investor. The purchase price is given to the warehouse lender to

pay for the advances and fees. The mortgage banker then keeps the remainder of the

proceeds from the sale. This cycle starts over on the next loan.

109. WHLs are typically used by mortgage bankers, such as Meritage, for a

variety of reasons including: (1) the control of funds by the mortgage banker, since

it has more control over the process of drawing loan documents; (2) permanent

funding, since typically unless the loans fail to comply with agreed upon criteria, the

lender is not obligated to buy back loans-the line of credit provides permanent

funding for the life of all loans in this program; (3) reduced risk, since once the asset

is funded, there is no additional mark-to-market and. posting of collateral and no

margin calls ; (4) unlimited loan volume, whether on or offbalance sheet , since WHL

programs can potentially fund an unlimited loan volume which enables specialty

lenders to enlarge their portfolios for maximum interest income and eliminate the

need to manage multiple sources of capital.



-64-


defendants Freeman, Herbert and Gross, E&Y's continued refusal certify NetBank's

prior financials after E&Y resigned led to NetBank's loss of its WHL, which was a

contributing factor to the demise of NetBank. As the Defendants were aware, ifE&Y

refused to certify NetBank's financials, making it impossible for NetBank to file

financial statements with the SEC, the Company's stock would be delisted which, in

turn , would cause the Company to lose its WHL. As alleged, the maintenance of its

WHL was essential to the continuation of operations at Meritage.

4. Mortgage Underwriting by Meritage

111. Underwriting . Meritage was comprised oftwo separate regional centers.

The Jacksonville, Florida center's function was to bring in new subprime mortgages;

the center in Oregon. was to package the mortgages into portfolios and then sell those

portfolios of loans to investors.

112. Meritage relied upon independent mortgage brokers to generate the sub-

prime mortgages that it packaged into portfolios for sale. According to a confidential

witness, who was senior managerial executive of Meritage during most of the Class

Period, as a result of the manner in which Meritage generated its subprime loans, the

Company had little control over the quality of the loans available to it for purchase.

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As a result, in order to reduce the risk of purchasing low quality loans that carried a

high risk of early default, it was necessary for Meritage to adopt stringent standards

of review and to develop strong long-term relationships with reliable brokers.

However, according to that confidential witness, in most instances, the brokers

bringing loans to Meritagc were "one-time broker[s]" for Meritage while others might

bring Meritage only a few loans and none of the brokers were "regulars" that had an

ongoing relationship with Meritage.

113. The types of subprime mortgages that Meritage sought were largely

dictated by the criteria that investors, the ultimate purchasers, wished to purchase. In

the Oregon segment of Meritage, Rick Baldwin was the individual in charge of the

secondary marketing for Meritage. As such, Baldwin worked with the investors who

ultimately purchased the portfolios of Meritage subprirne loans. According to a

confidential witness, who was senior managerial executive of Meritage during most

of the Class Period, the underwriting guidelines used by Baldwin and Meritage were

not uniform. Rather, Baldwin and Meritage utilized unique underwriting guidelines

for each investor. Individual agreements were then reached with each investor which

contained the responsibilities of the investor and Meritage including the terms under

which loans could be "put back" to Meritage. To address the attendant complexity,

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all of the various underwriting guidelines were combined into a single homogeneous

set of underwriting guidelines to be used by the Jacksonville branch when they

brought in the loans from mortgage brokers. According to this confidential witness,

the true purpose of the homogenous underwriting guidelines was to answer the

question "at the end of the day, wi 11 the investor buy the portfolio?" In sum, according

the confidential witness, ifthe answer to that question was "yes," then the loan would

be funded, if the answer was "no" the loan would not be funded.

114. As alleged, even where a loan meets the investor's underwriting

guidelines, such loans can nevertheless be "put back." Put backs were also referred

to as "buy backs" and "kickouts." During 2004 and 2005, loans from the portfolios

that Meritage had sold to investors began to be "put back" in ever increasing

numbers. Typically, a loan that met the investor's underwriting guidelines could be

put back if it fell into one of two categories: Early Payment Defaults (EPD) or First

Payment Defaults (FPD). EPD meant that the borrower defaulted or was delinquent

in the first 90-180 days of the loan. FPD meant that the borrower defaulted or was

delinquent on the loan's first payment.

115. According to a confidential witness who was a high-level manager in

NetBank's Finance Department during the entire Class Period and who reported to

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defendant Herbert and, later defendant Gross, among others, by as early as May 2006,

Herbert embarked on a plan to reduce the numbers of subprime loans on NetBank's

books by selling them to other financial institutions. Although defendant Herbert

continued to reassure the investing public on this point, his goal was to get NetBank

entirely out of the subprime lending market. When NetBank sold these loans, they

contained a provision of the sale that enabled the purchaser to put these loans back

to NetBank in the event of Early Payment Default (EPD) or because the loans were

defective for any reason.

116. By 2006, NetBank and its senior officers learned that the investors who

purchased its Meritage subprime loan portfolios had hired due diligence companies

to look for reasons to put back loans to Meritage even where they met the investors

guidelines.

117. In mid-2006, senior managers of Meritage and the Office of Thrift

Supervision, over a three weekperiod, examined Meritage's internal controls. Among

the findings was that Meritage had no process for revealing when the terms o f a loan

were changed in the middle of the teen of the loan which could lead to significant

losses to the company.

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118. Volume. By March 2005, during a monthly, internal .M.eri.tage

conference call, one item of discussion was the fact that certain market conditions,

such as the so-called two-year swap, was working against Meritage, thereby reducing

its already thin profits. According to a confidential witness who, during most of the

Class Period, was a senior managerial executive of Meritage, Russell Burdsall, who

was the NetBank Head of Mortgage Operations, acknowledged that NetBank's

mortgage profits were "razor-thin"; nevertheless, Burdsall directed Meritage

executives to "push the volume" ofthe subprime loans. According to that confidential

witness, Rick Baldwin, the then-Director of Capital Markets at Meritage Mortgage,

stated on a May 2005 conference call that although. investors were still buying the

Meritage portfolios, the profits had been reduced. For example, originally, Meri.tage

had received 106 basis points per loan, which dropped to 101 basis points per loan

at that time. As a result, by early 2005, although Meritage continued to produce loans,

it either lost money doing so or generated only minimal profit.

119. Rather than reveal the nature of the problems at Meritage, Defendants

embarked upon a strategy that de-emphasized risk controls and emphasized volume.

This strategy, while a potentially short term fix - aimed at increasing Meritage's

"razor thin profits" by volume rather than through quality - also increased the risk to

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Meritage and NetBank.

120. A former high-level manager in NetBank's finance department during

the entire Class Period who reported to Herbert and, later Gross, among others, was

astonished at how low Meritage had allowed the quality of loans and underwriting to

become, even providing subprime home loans to people who had gone bankrupt.

121. In addition to NetBank's increasingly lax underwriting standards, the

Company's increasing reliance on volume led it to accept and, ultimately, conceal.

losses on put backs that it was not required to accept. For example, in one incident,

Charles Mapson, NetBank's Chief Legal Officer, reviewed certain loans that an

investors wished to put back to the Company. Although Mapson is understood to

have determined that the loans actually met the guidelines and were put back long

after the 30 day guideline limit, he approved NetBank's repurchase of the loans to

ensure a continuing relationship with the investor which was essential to the

generation of an ever increasing volume of loans to support NetBank's razor thin

margins.

122. As set forth in the above section and as alleged elsewhere herein,

Defendants' made material misrepresentations and omissions regarding NetBank's

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transition as a subprime lender. As such, Defendants failed to properly disclose that

the nature of NetBank's core banking business was deficient, and that the focus of

NetBank's mortgage lending business had shifted from conservative, conforming

mortgages to making a late entry into subprime lending and other risky lending

practices.

123. OTG Audit Report. The above omissions have now been confirmed in

an Audit Report by the Office of Inspector General, Department of the Treasury,

dated April 23, 2008, titled "SAFETY AND SOUNDNESS: Material Loss Review

of NetBank, FSB" (the OIG Audit Report"). That Report presents, among other

things, the results of the OIG's review of the failure ofNetBank, FSB -- a failure that

the FDIC estimates will cost the Deposit Insurance Fund some $108 million.

Specifically, the OIG Audit Report found that large losses related to NetBank's

mortgage banking operations and commercial lease portfolio were among the

significant causes ofNetBank's failure. The OIG Audit Report cited that not only did

NetBank's mortgage lending practices contribute to its demise but also the fact that

the Company did not have a viable core banking business as it constantly touted:

While its mortgage banking operations did contribute substantially to

NetBank's earnings, by mid 2005 these earnings began to contract. At

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the same time, the secondary mortgage market was experiencing adramatic downturn. Rather than curtail its mortgage banking operationswhen faced with this deteriorating earnings scenario, NetBank insteadattempted to increase loan production by lowering its underwriting anddocumentation standards. Not surprisingly, this led to poor loan quality.NetBank sold these loans on the secondary mortgage market withrecourse provisions to investors. Recourse provisions out] me the termswhen the investor can request the thrift to buy back the loans.Ultimately, in 2006, NetBank had to make good on many of thoseprovisions and repurchase $182 million in loans. Ultimately, whenNetBank's mortgage operations became unprofitable, it did not have aprofitable core business to fall back on.

124. The OIG Audit Report provides a chronology of NetBank ' s entry into

the subprime lending market and the Company's subsequent collapse, which appears

to confirm Plaintiffs historical recitation set forth above, reporting in pertinent part:

NetBank responded to declining gains on the sale of loans by attemptingto maintain high loan volumes at the expense of the quality of loanoriginations. This resulted in an increase in repurchase requests from thebuyers of the sold loans. The thrift repurchased $1S2 million ofmortgage loans in 2006 and recorded related loss provisions totaling

$78.1 million.

Beginning with the first quarter of 2006, NetBank began reportingincreasing levels of quarterly losses. 'The thrift reported a pre-tax netloss of $203.6 million in 2006, with $80 million of that loss incurred inthe fourth quarter. NetBank's other business lines were not sufficientlyprofitable to offset the mortgage banking losses and, in some cases,contributed to the reported loss. In October 2006, NetBank's chairman

of the board/CEO resigned.

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In the latter half of 2006, NetBank management pursued several

strategies to counter its losses, including selling several business lines

and some loan portfolios and terminating the subprime mortgage

banking operation. These strategies were not successful, as evidenced

by the losses in 2006 which continued in 2007. An agreement to sell

almost the entire thrift was entered into with EverBank. Financial

Corporation in May 2007. As NetBank sold off or exited business lines

in preparation for the sale, its losses continued, totaling $120.2 million

for the second quarter of 2007. The sale to EverBank Financial

Corporation was not consummated because NetBank did not have

sufficient cash and saleable assets to close the transaction under the

terms of the agreement. With no viable plan for the thrift to restore

capital and achieve profitability, OTS exercised its authority to close the

institution and appointed FDIC as receiver on September 28, 2007.

125. Moreover, the O1G Audit Report confirmed that NetBank not only

surreptiously shifted its mortgage lending into the risky subprime market, but that

NetBank's claims of diversification were bogus, as the Company did not even have

a viable core banking segment:

Lack of Consistent Core Earnings

NetBank never established a consistent profitable core business ....

NetBank offered relatively high interest rates on deposit accounts and

covered these deposit costs by investing in a mix ofloan portfolios with

higher yields and credit risk. Rather than incurring loan origination

costs, NetBank paid premiums to acquire loan portfolios necessary to

achieve the asset mix it desired. The savings from not maintaining an

in-house loan origination function did not prove adequate to compensate

for the premiums paid for loans that the thrift purchased.

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Case 1:07-cv-02298-BBM Document 35-2 Filed 07/03/2008 Page 1 of 73

The net yield on the thrift's loan portfolios did not cover deposit costsand G&A. expenses to the extent necessary to produce core earningsperformance at the peer group median level. As a result, as discussedabove, NetBank. acquired Market Street and RBMG and became entirelydependent on mortgage operation income for profitability. The initialprofitability of this segment masked underlying weaknesses, includingunusually high operating expenses, ineffective controls of its varioussubsidiaries and insufficient core earnings.

B. Defendants' Sham Restructuringof NetBank

126. On March 16, 2005 , Defendants filed the NetBank's Form i 0-K for the

fiscal year ended December 31, 2004. That filing reported the Company's financial

condition as of December 31, 2004 and financial results for fiscal year 2004,

including that net income for 2004 was some $4.22 million or $0.09 per share,

compared to net income of some $50.514 million or $1.04 per share, for 2003. That

Filing also described NetBank's operations and its supposed restructuring efforts,

including for example that:

During 2002 and 2003, the retail banking segment implemented anumber of strategies to improve earnings. It restructured its portfolio ofassets away from higher to lower risk loans.

NetBank believes that its deposit base will continue to grow as Internetusage and Internet-based commerce grow. NetBank believes that it cancontinue to invest those deposits profitably in mortgage loans heldtemporarily for sale and loans held for investment. NetBank also

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believes that its non-interest earnings in the form of fees and gain onsale resulting from its financial intermediary and transaction processingactivities will provide a better diversity of earnings than the traditionalbanking model.

127. During a May 4, 2005, conference call with investors, Defendant

Freeman assured investors that not only was the restructuring plan effective , but that

the banking segment was can ying a significant portion of earnings:

We continue to make measurable progress in diversifying your

Company's revenue across its three primary operating segments. You

take a peek for a minute at the long-term view, you see a company with

a strong business plan, a rapidly improving bank that has begun to carry

a significant portion of the Company's earning obligation, and I can't

stress again how much we have improved bank performance over the

past 24 months.

We're now two years into our evolutionary strategic plan. Since the

beginning of the process, we've always felt the Company was a good

investment on the strength of our business plan, capital position, and

management team. This belief is even stronger today given the

measurable progress we've had against many of the critical objectives

we detailed for you. Our top priority has always been to generate

significant rewards for our investors and we think we can do that for

shareholders who share this long-term view.

128. On the strength of defendant Freeman's assurances, NetBank's stock

price rose from $8.38 on May 3, 2005, to $8.53 on May 4, 2005.

129. For a time, the new NetBank's attempt to shift away from its core retail

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banking model under Freeman and Herbert appeared to be working. On August 3,

2005 , defendant Freeman reassured the investing public, stating:

At the bottom line, what investors are getting with Net Bank is as

follows -- a company with an increasingly balanced, stable earnings

profile, an undervalued lending franchise with tremendous earning

power over the full economic cycle, an attractive base of multi-product,

high-value retail bank customers.

130. However, by 2006, due to the combination of the bursting of the U.S.

housing bubble and the mounting exposure from subprime and other risky mortgage

practices, NetBank's operations and finances faced increasing pressure. Demands for

repurchases of loans and defaults increased significantly and investors began to limit

their purchases of mortgage portfolios. As a result, the cash available to NetBank to

lend to borrowers was constrained. This liquidity crisis led NetBank to restructure the

Company to conserve capital and preserve tangible book value. NetBank's purported

"restructuring" had four major components: (1) the sale of its mortgage servicing

platform; (2) the sale or exit of the Company's non-conforming mortgage business;

(3) the sale of other non-core operations; and (4) the raising of capital through a

private placement of NetBank common stock.

131. In February of each year, the NetBank Board of Directors met and

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received a presentation from NetBank's top management regarding the Company's

long-term strategic plan. According to a confidential witness who was a senior

corporate officer ofNetBank during most of the Class Period and who provided input

directly to Freeman, Herbert, and Gross, in February 2006, the NetBank Board of

Directors were aware of the Company 's perilous situation and demanded that the

Company be restructured.

132. On March 15, 2006, NetBank Filed its Form 1.0-K for the fiscal year

ended December 31, 2005, which was signed by defendants Freeman, Herbert,

Muller, Adams, and. Johnson. That filing reported the Company's financial condition

as ofDecember 31, 2005 and financial results for fiscal year 2005, including that the

Company suffered a net loss for 2005 of some $180, 000 or $0.00 per share,

compared to net income of some $4.22 million or $.09 per share, for 2004. The 2005,

Form 10-K also described NetBank's operations and. its supposed restructuring

efforts, including for example that:

In 2003, we announced a strategy to diversify our earnings so that onethird is provided by each of our principal operating segments: retailbanking, financial intermediary and transaction processing. Over thelong-term, our goal is to achieve a better, more stable, balance acrossour different segments.

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133, On May 1, 2006, after repeatedly assuring investors about the success

of its restructuring plan, NctBank began to implement the Board 's February 2006

directive and announced a plan to sell its mortgage servicing platform along with

most of its mortgage servicing rights portfolio. The Company represented that

"[m]anagement estimates such a sale would likely free up between $20 and S35

million in risk-based capital that the company currently has allocated to its servicing

asset . Management would then have the opportunity to redeploy this capital in other

business initiatives that it believes can generate higher returns or better serve

shareholder interest." NetBank also represented that the proposed sale was part of

"management ' s continuous, proactive capital management program ." After years of

purporting to expand its sound core banking strategy to grow and deliver shareholder

value by leveraging those assets, NetBank acknowledged that:

"The economic and market environments have changed dramatically

since we initiated our plan, and we have not been able to achieve the

level of growth in the servicing asset we had anticipated," Freeman

added. "Given prevailing business conditions, we have determined the

mortgage servicing business no longer represents the best use of ourcapital."

"Our obligation first and foremost is to create value for ourshareholders," Freeman concluded. "Although we will continue to planfor the long-term and persist in the face of short-term operational

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pressures when it is right to do so, we will also remain flexible and havethe conviction to revise our business strategy when it clearly furthers theinterest of our shareholders."

Other details or likely results of the proposed sale include:

-The sale would entail a significant one-time restructuring charge.

However, management would seek to moderate the impact of the charge

on the company's tangible book value. The effect on tangible book

value would be part of management's criteria in approving any

transaction.

As of March 31, the company's core servicing asset was comprised of

$ 13.0 billion in loans. Management believes the underlying mortgage

servicing platform could be scaled up to the $35.0 billion mark almost

immediately using the operation's existing facility and infrastructure.

134. On this news, NetBank's stock price rose from $6.84 per share on May

1, 2006 to $6.94 per share on May 2, 2006.

135. On May 2, 2006, a media report in American Banker discussed

NetBank's plan to sell off its mortgage servicing platform and operation. In the

article, Defendant Freeman was quoted portraying the sale as a benefit to the

Company's strong banking segment:

Such a sale would free up to $35 million in risk-based capital -- "a pretty

big number for us," said Douglas K. Freeman, NetBank's chairman and

chief executive. The capital could be redeployed "back into our Internet

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bank or other more profitable activities," he said in an interview. Hewould not say what those other activities were, and he made it clear thathe has no interest in getting into brick-and-mortar retail banking, despiteone analyst's advice that he should. But he reiterated that NctBank isreexamining its game plan. When the capital is freed up, the .$4.8-billionasset company will be able to gather more deposits and increase assets,Mr. Freeman said. "We continue to find great growth on the deposit sideofthe business. ... Your balance sheet has to balance, last time I looked."

1 36. The statements set forth. in the above subsection were materially false

and misleading because they failed to disclose that the Company's financial distress

was due to the failure of its core operations, that selling off parts of its mortgage

business or other non-core operations would not be enough to resuscitate the

Company and that the Company's accounting for its mortgage business was improper.

137. Without disclosing its mounting troubles with the SEC, its auditor E&Y

and its core retail business, on October 5, 2006, NetBank announced that defendant

Herbert would assume the position of CEO, replacing defendant Freeman. In a Form

8.K filed with the SEC on October 5, 2006, defendant Muller confirmed that

NetBank's value was in its core banking business and conforming mortgages, but

omitted discussion of the fact that the Company's non-conforming business was at

that time highly troubled and threatened the viability of the Company itself:

The board believes the company's core strengths reside in its banking

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and conforming mortgage activily..Relentless focus on these operations

is the surest path to increasing shareholder value. We think [Herbert]

is the right person to guide the company through the changes we will

make to pare down costs and leverage these businesses more effectively.

"We believe our bank and conforming mortgage businesses have upside

potential, and I am excited about the prospect of leading the company

in its next stage of development," says Herbert. "Our main objective

over the next three to six months will be to stabilize the company's

operating profile and return to profitability as quickly as possible. As we

mentioned recently, we anticipate announcing a deal to sell the majority

ofourmortgage servicingportfolio soon. We are also actively exploring

alternatives for our non-conforming mortgage business. You will now

see us move quickly to execute on needed changes in other lines of

business outside ofthe core banking and mortgage operations. We have

a talented base ofassociates that I believe will support andfully engage

in this sapid refocus.

138. On this news , NetBank's stock. price rose from $6.30 per share on

October 5, 2006 to $6.33 per share on October 6, 2006.

139. On October 13, 2006, NetBank issued a press release, which was then

filed in a Form 8-K on October 16, 2006 that signed by defendant Gross. That press

release reported that NetBank had sold the servicing rights on $8.5 billion of

mortgages, which represented 70% of its mortgage servicing portfolio, to two buyers,

but took a higher-than-expected $19.3 million loss. NetBank continued to conceal its

difficulties with the SEC by omission. Rather than disclosing the truth, NetBank

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reassured investors by emphasizing that it would no longer have the same level of

exposure to impairment and hedge-related losses. In part, the press release stated:

the company has sold most of its mortgage servicing rights ("MSRs")associated with conventional, agency-eligible loans. These MSRsaccounted for approximately 70% of NetBank's portfolio, and theunpaid principal balance ("UP.B") on the underlying mortgages totaled$8.5 billion. The MSRs were sold in two separate transactions. Thelarger, more significant deal involved MSR.s for Fannie Mae and FreddieMac loans. These MSRs had a related UPB of approximately $8.2billion, and they were acquired by IXIS Real Estate Capital Inc.("IXIS"). A different buyer purchased a pool of Ginnie Mae MSRs withUPI3 of approximately $230 million. Both transactions closed onSeptember 29 and were recognized as third quarter events.

Financial and other details of the sale include:

One-time expenses of approximately $0.61 per share. The combinedsales price for the MSRs was $119 million, which fell below thecarrying value that the company had recognized on these particularMSRs. As a result of this difference, the company recorded an after-taxloss of $19.3 million on the sale. The company also elected to liquidatethe Ginnie Mae mortgage-backed securities that it held as an on-balancesheet hedge. The company recorded an after-tax loss of S8.7 million onthe sale of those securities. These charges along with other transaction-related costs equate to after-tax expenses of $28.1 million or S0.61 pershare.

Limited impact on tangible book value. The sale of the company's on-balance sheet hedges improved the company's equity position on anafter-tax basis by $1.3.8 million or $.30 per share and partially offsets theone-time expenses outlined above at the equity or tangible book level.

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As hedges, the Ginnie Mae securities were valued on a mark-to-marketbasis. The value of these hedges improved throughout the third quarter.The company ultimately realized a smaller loss on these hedges than the

unrealized loss it recognized in its equity calculation on June 30, 2006.x* ::x

"The cost of selling these MSR.s exceeded our initial expectations, but

we believe the entire transaction and the timing of it serve the long-term

interest ofour company and shareholders," said Steven F. Herbert, chief

executive officer. "The transaction immediately improves the operating

profile of'the company as well as our bottom line. By reducing the size

ofour MSR portfolio, we eliminate significant earnings volatility. We

will no longer have the same level ofexposure to impairment and hedge-

related losses. The bank's net interest margin should see incremental lift

following the liquidation ofthe on-balance sheet hedges. We also felt

the intrinsic value ofthe sub-servicing contractprovided a ineaningfid

offset to the lower price."

140. On this news, NetBank's stock price rose from $6.11 per share on

October 13, 2006 to $6.17 per share on October 16, 2006, the next trading day.

141. The statements set forth in the above subsection. were materially false

and misleading because they failed to disclose that the Company' s financial distress

was due to the failure of its core operations , that selling off parts of its mortgage


Company, that the Company' s accounting for its mortgage business was improper and

omitted that the SEC had challenged the Company's improper accounting treatment.

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142. NetBazik's purported "strategic restructuring" continued when, on

November 6, 2006, the Company issued a press release in which it announced that it

had exited its various non-conforming loan financing businesses by selling Meritage

and Beacon. The Company's non-conforming financing operations were so deficient

as to be worthless. In the press release NetBank explained:

The company did not receive any material financial or otherconsiderations under the agreements, but management viewed them asa positive since they allowed the company to mitigate substantialseverance and shutdown costs that the company would likely haveincurred otherwise. Since the agreements did not cover the full scope ofthe operations, the company still has personnel and other commitmentsto address to fully exit both lines of business. Management currentlyexpects to record pre-tax expense of $6.0 million to S7.5 million in thefourth quarter to cover those remaining obligations. The company hadalready written off the goodwill related to both businesses.

"Since the beginning ofOctober, we have been working aggressively torefocus the company on its core banking and confor°mning mortgagecompetencies ," said Steven F. Herbert , chief executive officer.

"We said then that our priorities were to exit or spin off anyunderper_forming or non-core businesses so we cou ld restore thecompany to profitability as quickly as possible and to improve thecompany 's overall operating profile. Our decision to exit the non-conforming mortgage and RV, boat and aircraft lending businessescontribute to those goals in a meaningful way, especially when youconsider the steepness of the quarterly losses we have been incurring inthe non-conforming channel."

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"We also committed to protecting capital as much as possible during this

process," Herbert continued. "We were happy to execute the

transactions that we did since they saved us real dollars in severance and

shutdown costs. But, regardless of the deals, it was critical for us to

move quickly on these businesses. The cost of carrying them for another

quarter or two would have destroyed more value than we probably could

have derived under the best possible transaction circumstances."

The company announced its plan to refocus on its banking and

conforming mortgage operations along with a change in executive

leadership on October 3, 2006. Ivlanagelment has indicated that it

intends to exit the lines ofbusiness it considers non-core and to make

any other related business adjustments by the end ofthefirst quarter of

2007, although it hopes to complete the bulk of the effort by the end of

2006.

143. The statements in the above subsection were materially false and

misleading because they failed to disclose that the Company' s financial distress was

due to the failure of its core operations, that selling off parts of its mortgage business

or other non-core operations would. not be enough to resuscitate the Company and

that the Company's accounting for its mortgage business was improper. In addition,

it failed to disclose that the Company' s tangible book value was declining rapidly,

even with the restructuring , due to the failure of the Company' s core businesses.

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C. Defendants Falsely Assure Investors That TheyCan Rev on NetBank's Book Value

144. On May 4, 2005, NetBank held a conference call with analysts and

others to discuss the Company's financial results for the first quarter of2005. During

that call, Defendant Freeman stated:

Book values slipped by $0.20 to $8.70 during the quarter. The declinein interest rates environment experienced during the quarter affected thevalue of securities and the banks investment portfolio, most of thedecrease in book values attributable to an unrealized loss of netportfolio. I point out that this is simply a one-dimensional view. Overtime we fully expect book value to trend upward.

1.45. In an effort to mislead investors into believing that the NetBank's book

value was an accurate measure of their investment, NetBank continued to repurchase

shares of its common stock and continued to reassure investors about the value of

those shares. For example, during NetBank's May 4, 2005, conference call with

analysts, Defendant Freeman reported:

The Board of Directors approved a dividend of $0.02 per share andauthorized an additional 1 million shares for our stock repurchaseprogram. As we reported in the press release, we repurchasedapproximately 424,000 shares at an average price of $9.29 per shareduring the quarter. As current tradingprice, we continue to believe thatour stock represents the best investment ofavailable capital.

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146. Less than one year later, on May 1, 2006, NetBank announced a plan to

sell its mortgage servicing platform along with most of its portfolio of mortgage

servicing rights. However, recognizing the importance investors placed on NetBank's

book value as a measure of their investment, NetBank assured investors that it would

undertake to moderate the impact from the sale on the Company's tangible book

value as follows:

Other details or likely results of the proposed sale include:

• The sale would entail a significant one-time restructuring charge.

However, management would seek to moderate the impact ofthe charge

on. the company's tangible book value. The effect on tangible book

value would be part of management's criteria in approving any

transaction.

147. fn a November 8, 2006 press release NetBank explained:

Tangible book value is defined as total shareholders' equity reduced byrecorded goodwill and other intangible assets. Tangible book value pershare is defined tangible book value divided by total common sharesoutstanding. These non-GAAP financial measures exclude from totalshareholders' equity our recorded goodwill and other intangible assets.Management believes that these non-GAAP financial measures, whenconsidered together with the GAAP financial measures, provideinformation may be helpful for those investors who seek to evaluate ourtotal stockholders' equity without giving effect to goodwill and otherintangible assets. Management also believes that these non-GAAPfinancial measures enhance the ability of investors to analyze thecompany's business trends and to better understand the company's

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financial condition . In addition , the company may utilize non-GAAP

financial measures as a guide in its forecasting, budgeting, and

long-term planning process and to measure operating performance for

some management compensation purposes . Any analysis ofnon-GAAP

financial measures should be used only in conjunction with amounts

presented in accordance with GAAP, including total shareholders' equity

and goodwill and other intangible assets.

148. According to BuusinessWeek.coyrn:

Tangible book value indicates the theoretical dollar amount per common

share one might expect to receive from a company's tangible "book"

assets should liquidation take place.

Generally, book value is determined by adding the stated value of the

common stock, paid-in capital and retained earnings, and then

subtracting intangible assets (excess cost over equity of acquired

companies, goodwill and patents), preferred stock at liquidating value

and unamortized debt discount. Then divide that amount by the

outstanding shares to get book value per common share.

149. On May 10, 2006, NetBank held an conference call with analysts and

others to discuss the Company's financial results for the first quarter of 2006.

Significantly, NetBank knew and understood that investors were valuing the

Company based on its book value, and understood the need to avoid negatively

impacting that calculation, notwithstanding other financial realities. For example, the

same May 2, 2006, American Banker article quoted above noted that investors priced

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NetBank's shares on the basis of book value, and not on the basis of earnings, and as

a result, a larger than expected restructuring charge for the sale of its mortgage

servicing rights would hurt bookvalue and, in turn, the Company's stock price. Thus,

the Defendants knew that it was imperative that they continue to reassure investors

about the Company's book value and to ignore certain financial realities in favor of

minimizing any negative impact on the Company's book value.

1.50. On November 8, 2006, NetBank announced its operating results for its

third quarter ended September 31, 2006. NetBank reported dramatic losses of $73.3

million or $1.58 per share for the quarter, compared with an after-tax loss of S 1.4

million or $0.03 per share during the sane quarter in the prior year. In part, the press

release stated that NetBank:

a leading mortgage lender, today reported financial results for the

quarter ended September 30, 2006. The company recorded an after-tax

loss of $73.3 million or $1.58 per share for the period, compared with

an after-tax loss of $1.4 million or $.03 per share during the same

quarter a year ago. On a year-to-date basis, the company recorded an

after-tax loss of $116 million or $2.50 per share, versus a net loss of

$1.1 million or $.02 per share during the first nine months of 2005.

Book value declined by $1.22 per share from $7.48 on. June 30, 2006 to

$6.26 on September 30, 2006. However, the impact on the company's

tangible book value was substantially less. Tangible book value declined

$.70 per share from $5.80 on June 30, 2006 to 55.10 on September 30,

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2006. On an after-tax basis, the reported loss included a $19.5 million

expense of non-deductible goodwill and a $2.4 million expense of

deductible goodwill, both of which did not negatively impact tangible

book value. In addition, the company sold certain on-balance sheet

investments allocated as economic hedges of its mortgage servicing

rights ("MSRs") during the quarter. The Unrealized loss on these

securities was already deducted from tangible book value on June 30

through other comprehensive loss included in the equity section of the

balance sheet. Thus, the realized loss on those securities did not impact

tangible book value. (Details related to amounts excluded from tangible

book value are provided in the attached Reconciliation of Non-G.AAP

Financial Measures.)

1 51 . The statements set forth in the above subsection were materially false




Company and that the Company's accounting for its mortgage business was

improper. In addition, it failed to disclose that the Company's tangible book value

was declining rapidly even with the restructuring due to the failure of the Company's

core businesses.

D. Defendants Make Additional False Assurances to

Investors After E&Y Resigns

152. On November 9, 2006, Defendant Gross signed a Form S-K filed by

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NetBank with the SEC. In the Forin 8-K, the Company revealed that on October 10,

2006, E&Y had resigned as NetBank's independent auditor. E&Y's resignation as the

Company's independent accountant became effective on November 9, 2006, with the

filing of the Company's Quarterly Report on Forln 10-Q for the three-month and

nine-month periods ended September 30, 2006.

153. In NetBank's November 9, 2006, Form 8-K, Defendants discussed

certain material weaknesses in the Company's internal controls, stating:

In the Company's Annual Report on Form 10-K for the fiscal year ended

December 31, 2004, which the Company filed with the SEC on March

16, 2005, Management's Annual Report on Internal Control over

Financial Reporting stated, and E&Y's report on internal controls

reiterated, that because of the material weakness disclosed in those

reports, the Company's internal control over financial reporting was not

effective as of December 31, 2004, based on the criteria set forth by the

Committee of Sponsoring Organizations of the Treadway Commission

in Internal Control - Integrated Framework. The material weakness in

those reports concerned the Company's controls over the determination

and estimation of the change in fair value of the Company's portfolio of

mortgage loan funding commitments where the interest rate had been

locked and the related financial derivatives ("rate locks"). In 2005, the

Company implemented certain changes to its internal controls to address

the material weakness over the Company's rate locks and determined

that the material weakness existing at December 31, 2004 was corrected.

154. Item 4.01(a) of Form 8-K requires the registrant, here NetBank, to

disclose the information required by Regulation S-K Item 304(a)(1) and Item

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304(a)(3) when its auditor resigns. The disclosures required by Regulation S-K Item

304(a)(I) regarding disagreements between a registrant and its auditor include: (iv)

state whether during the registrant 's two most recent fiscal years and any subsequent

interim period preceding such resignation, declination or dismissal there were any

disagreements with the former accountant on any matter of accounting principles or

practices, financial statement disclosure, or auditing scope or procedure, which

disagreement(s), if not resolved to the satisfaction of the former accountant, would

have caused it to make reference to the subject matter of the disagreement(s) in

connection with its report. Also, (A) describe each such disagreement; (B) state

whether any audit or similar committee of the board of directors, or the board of

directors , discussed the subject matter of each of such disagreements with the former

accountant; and (C) state whether the registrant has authorized the former accountant

to respond fully to the inquiries of the successor accountant concerning the subject

matter of each of such disagreements and, ifnot, describe the nature ofany limitation

thereon and the reason therefore. The disagreements required to be reported in

response to this Item include both those resolved to the former accountant's

satisfaction and those not resolved to the former accountant's satisfaction.

Disagreements contemplated by this Item are those that occur at the decision-making

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level, i.e., between personnel of the registrant responsible for presentation of its

financial statements and personnel of the accounting firm responsible for rendering

its report.

155. By virtue of filing Netbank's November 9, 2006 Form 8-K, Defendants

violated Item 4.01(a) and the related disclosure requirements by falsely representing

that there were no material disagreements between the Company and E&Y, as

follows:

During each ofthe fiscal years ended December 31, 2004 and December

31, 2005 and the subsequent interim period from January 1, 2006

through the effective date of E&Y's resignation on November 9, 2006:(i) there were no disagreements between the Company and E&Y on any

matter of accounting principles or practices, financial statement

disclosure, or auditing scope or procedure, which disagreements, if not

resolved to the satisfaction of E&Y, would have caused E&Y to make

reference to the subject matter of the disagreement in connection with

its reports on the consolidated financial statements for such years; and

(ii) except as set forth in the next paragraph, there were no "reportable

events" (as defined in Item 304(a)(1)(v) of Regulation S-K).

156. NetBank facilitated the foregoing false and misleading statement in the

Form 8-K by stating, "The Company has provided E&Y with a copy of the above

disclosures and has requested that E&Y furnish the Company with a letter addressed

to the SEC stating whether it agrees with such statements made by the Company. A

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copy ofthat letter, dated November 9, 2006, is attached hereto as Exhibit 16.1." E&Y

had certified to the SEC on November 9, 2006, that "We have read Item 4.01 ofForm

8-KJA dated November 9, 2006, of NetBank, Inc. and are in agreement with the

statements contained in the first four paragraphs in the section, "Item 4.01 Changes

in Registrant's Certifying Accountant." Included among the "first four paragraphs"

referenced by E&Y in its November 9, 2006, certification was NetBank's foregoing

certification that were no disagreements between the Company and E&Y.

157. Despite the representations of NetBank and E&Y, according to a

confidential witness, who was a senior executive ofNetBank during the entire Class

Period, and who had regular daily interaction with defendants Freeman, Herbert and

Gross, E&Y had a significant ongoing disagreement with NetBank regarding the

calculation of the Company's hedge effectiveness under SFAS 133.

158. NetBank had an inventory of mortgages for which they maintained

servicing rights. Under FAS 133, NetBank was required to show its hedge

effectiveness relating to those rights and perform calculations on a monthly basis.

However, according to a confidential witness who was a senior executive ofNetBank

during the entire Class Period and who had regular daily interaction with defendants

Freeman, Herbert and Gross, E&Y advised NetBank and its senior management that

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the Company's hedge effectiveness testing under FAS 133 was not being conducted

frequently enough to be reliable and directed NetBank to perform the hedge-

effectiveness on a daily basis. E&Y also directed NetBank to re-calculate the hedge-

effectiveness for previous years back to 2002.



defendants Freeman, Herbert and Gross, NetBank was also in negotiations with the

SEC regarding the frequency with which it performed its hedge-effectiveness under

FAS 133. NetBank ultimately reached an agreement with the SEC in which the SEC

would permit NetBank to perform a re-calculation for one month out of each quarter

in an attempt to demonstrate that the hedging was effective, However, E&Y refused

to accept the proposal claiming that it did not believe that it was adequate solution.

For its part, NetBank and its senior management, upon information and belief, refused

to accept the assessment ofE&Y. On the basis of that disagreement between NetBank

and E&Y, E&Y resigned as Netlank's auditors.

160. According to a confidential witness who was a NetBank officer

employed in the Corporate Finance Department throughout the Class Period and who

had direct dealings with top management including defendant CFE Herbert, E&Y

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also told NetBank that E&Y was resigning because it was not comfortable with the

Company 's financial statements.

161. According to a confidential witness who was a senior corporate officer

of NetBank during most of the Class Period and who provided input directly to

defendants Freeman, Herbert, and Gross, E&Y also claimed that its decision to

resigned was motivated , at least in part , by its fear of the "potential liability

associated with NetBank."

162. According to a confidential witness who was a high-level manager in

NetBank's Finance Department during the entire Class Period and who reported to

Herbert and, later Gross, among others, defendants Herbert and Gross were "furious"

with E&Y' s decision to resign as NetBank ' s auditors and claimed to believe that

E.&Y did so in an effort to distance itself from NetBank.

163. Despite the serious disagreements between NetBank and E&Y and their

mutual omission ofthose disagreements , NetBank attempted to further downplay the

reasons for E&Y's resignation, stating that "[t]he audit reports of E&Y on the

Company's consolidated financial statements for the fiscal years ended December 31,

2004 and 2005 did not contain an adverse opinion or a disclaimer ofopinion and were

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not qualified or modified as to uncertainty, audit scope or accounting principles."

164. Although it could no longer fail to inform the investing public that E&Y

had resigned as NetBank's auditor, Defendants also continued to omit that months

before NetBank had received a comment letter from the SEC regarding the

Company's application of SFAS 133 to the accounting of its mortgage servicing

rights and loans held for sale.

165. With these reassurances, NetBank's stock price increased from $4.99 per

share on November 9, 2006 to 55. 02 per share on November 10, 2006.

1.66. E&Y also continually refused to re-issue its 2004 and 2005 audit report

for inclusion in NetBank's 2006 Fonn 10-K unless and until NetBank resolved the

SEC's dispute with respect to the Company's application of FAS 133 to the

accounting of mortgage servicing rights and loans held for sale. By the time of its

collapse, NetBank had never resolved. the SEC's issues or filed audited financial

results for 2006.

167. The statements set forth in the above subsection were materially false



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Company and that the Company's accounting for its mortgage business was

improper. NetBank also omitted that, in fact, the reason for the failure to timely file

was Defendants' failure to comply with GAAP in valuing its core mortgage portfolio

and, as a result, its tangible book value.

168. On January 3, 2007, in the final phase of its purported restructuring,

NetBank announced a private placement of 6,500,000 shares of its common stock at

a price of $3.90 per share, with proceeds of approximately $23.7 million.

169. The private placement closed on January 5, 2007. On January 8, 2007,

NetBank issued a press release, which was then filed in a Form 8-K on that same day

which was signed by defendant Gross. That press release stressed that this was one

of the final steps in its restructuring and was intended to, among other things,

"maintain [NetBank's] optimum capitalization". In part, the press release stated:

"We are pleased with the transaction and believe it serves the best

interest of long-term shareholders," said Steven F. Herbert, chief

executive officer. "We are in the final phase of the corporate

restructuring plan we started three months ago. The plan centers on

returning the company to profitability as quickly as possible by exiting

underperforming businesses and refocusing attention on our core retail

and small business banking operations as well as our prime mortgage

businesses. We believe the additional capital will allow us to maintain

-98-

Case 1 : 07-cv-02298 -BBM Document 35-2 Filed 07/03/2008 Page 26 of 73

optimal capitalization within the bank; support new asset and deposit

growth; and potentially invest in other key initiatives."

"We were deliberate in balancing the benefit of additional capital with

the dilution to existing shareholders that this transaction represents,"

Herbert continued. "By limiting the issuance to a relatively small

number of shares, we were able to keep the dilution to approximately

$0.10 per share based on a closing market price of $4.64 the day that we

priced the deal."

170. As a result of expected dilution of NetBank shares, NetBank's stock

price slipped in a roughly equal amount, from $4.30 per share on January 3, 2007 to

$4.14 per share on January 5, 2007.





Company and. that the Company's accounting for its mortgage business was

improper.

172. On January 3, 2007, in a Form 8 -K Filed with the SEC in connection with

the private placement discussed above, NetBank informed investors for the first time

that as a result of E&Y's resignation on October 10, 2006,and the Company's

-99-


inability to find a replacement auditor, the filing of its 2006 Form 10-K might be

delayed. NetBank also revealed that the Company's stock may be delisted by the

NASDAQ stock exchange if the 2006 Form 10-K was not filed by March 16, 2007.

17 3. Despite the potentially dire consequences delisting would have on

NetBank's common stock and its public shareholders, the Company downplayed the

problem. Rather, it reassured investors by falsely claiming that the Company simply

had not yet been able to find a replacement despite the efforts of NetBank's Audit

Committee and that there had been no disagreements between NetBank and Ernst &

Young:

On October 10, 2006, Ernst & Young LLP ("E&Y"), the independent

registered public accounting firm of the Company for the fiscal year

ended December 31, 2005, resigned effective upon the filing with the

Commission of the Company's Quarterly Report on Form 10-Q for the

three-month and nine-month periods ended September 30, 2006. E&Y's

resignation as the Company's independent registered public accounting

firm became effective on November 9, 2006, with the filing of the

Company's Quarterly Report on Form 10-Q for the three-month and

nine-month periods ended September 30, 2006. During each ofthe fiscal

years ended December 31, 2004 and December 31, 2005 and the

subsequent interim period from January 1, 2006 through the effective

date of E&Y's resignation on November 9, 2006 there were no

disagreements between the Company and E&Y on any matter of

accounting principles or practices, financial statement disclosure, or

auditing scope or procedure, which disagreements, if not resolved to the

satisfaction of E&Y, would have caused E&Y to make reference to the

subject matter of the disagreement in connection with its reports on the

-100-


consolidated financial statements for such years.

Since prior to the effective date of E&Y's resignation, the Audit

Committee of the Board of Directors of the Company has been engaged

in the process of selecting an independent registered public accounting

firm ("Auditor") for the fiscal year ending December 31, 2006.

174. As a result of NetBank's reassurances, its stock price remained stable,

closing at $4.30 per share on both January 3 and 4, 2007.


and misleading in that they falsely led investors to believe that the delay in filing the

2006 Form 10-K was not due to a. substantive issue, but rather was merely the

procedural result of not being able to engage an auditor in time to file. These

statements omitted to state that in fact, the reason. for the failure to timely file was the

Defendants ' s failure to comply with GAAP in valuing its core mortgage portfolio

and, through that, its tangible book value.

176. More than three months after E&Y's resignation, in a February 16, 2007

idling with the SEC on Form 8-K, NetBank announced that it had selected Porter

Keadle Moore , LLP ("PKM"), as its new independent auditor and repeated the false

and misleading statement that it was the procedural delay in selecting a new auditor

-101-


that might prevent NetBank from timely filing the 2006 Form. 10-K. Further

misleading investors, the Company falsely represented to shareholders that it

expected to file the 2006 Form. 10-K no later than June 31, 2007:

On February 13, 2007, NetBank, Inc. (the "Company") engaged PorterKeadle Moore, ,LP ("PKM") as its new independent registered publicaccounting firm for the fiscal year ended December 31, 2006.

[DJue to the timing ofthe engagement ofPKk[, the Company does notexpect that PKMwill be able to perform and complete the audit ofour2006 financial statements, and related auditor attestation regarding ourinternal control over financial reporting, by our compliance deadlineof'Mareh 16, 2007, the last date the Company is permitted to timely fileits Annual Report on Form 10-K for the year ended December 31, 2006("2006 Form 10-K") with the SEC. The Company currently believes thatthe 2006 audit will be completed in June 2007 and expects to file the2006 Form 10-K with tie SEC on or before June 30, 2007, although noassurance can be given.

177. On February 21, 2007, NetBank issued a press release, which was then

filed in a Form S-K on that same day which was signed by defendant Gross. That

press release announced the Company's preliminary unaudited results for the year

ended December 31, 2006. Attempting to explain why it was still unable to issue final

audited results, NetBank again created the impression that the only reason the filing

of its 2006 Form l 0-K may be late was that PKM had only been "recently engaged"

and that it expected the 2006 Form 10-K would be filed soon stating:

-102-


The results set forth in this press release are preliminary and unaudited.

As previously reported, the company recently engaged Porter Keadle

Moore, LLP ('PKM'' ) to replace Ernst & Young LLP as its independent

auditor. These preliminary results are subject to potential adjustments,

which may be material, arising from subsequent events or the audit of

the company's financial statements for the year ended December 31,

2006 by PKM. The company currently believes that the 2006 audit, and

related auditor attestation regarding the company's internal control over

financial reporting, will be completed in June 2007 and expects to file

its Annual Report on Form I 0-K for the 2006 fiscal year with the SEC

on or before June 30, 2007, although no assurance can be given.

178. As a result of defendants' false assurance on February 16 and 21, 2007,

NetBank's stock rose from $3.55 per share on Friday, February 16, 2007 to $3.62 per

share on February 21, 2007.



2006 Form 10-K was not due to a substantive issue, but rather was merely the

procedural result of not being able to engage an auditor in time to file . These

statements omitted to state that in fact, the reason for the failure to timely file was the

failure of Defendants to comply with GAAP in valuing its core mortgage portfolio


-103-


E. NetBank Continues to Falsely Reassure Investors About

the Company's Condition and Operations

180. On February 21, 2007, NetBank announced its preliminary unaudited

results for the year ended December 31, 2006. NetBank recorded an after-tax loss of

$86.3 million or $1.86 per share during the fourth quarter, compared with net income

of $895,000 or $0.02 per share during the same quarter in 2005. NetBank further

recorded a net loss of $202 million or $4.36 per share for the full year, compared with

a net loss o f $180,000 or 50.00 per share for 2005.

181. The February 21, 2007 report of NetBank's fourth quarter and year end

2006 financial results also contained a section called "Key items worth noting" in

which management represented that the "worst of the non-conforming loan

repurchase problem is now behind the company" and that the impact of the

restructuring on the Company's tangible book value was "lessened, being reduced

only to $3.50 on December 31, 2006 from $5.10 on September 30, 2006." The press

release also stated:

Management believes the worst of the non-conforming loan repurchaseproblem is now behind the company given the accelerated repurchaserequests already received relative to the limited non-conformingproduction over the second half of 2006.

-104-


Impact on Tangible Book Value Lessened. Book value declined by

$1.94 per share from $6.26 on September 30, 2006 to $4.32 on

December 31, 2006. However, the impact on the company's tangible

book value was less. Tangible book value declined by $1.60 per share

from $5.10 on September 30, 2006 to $3.50 on December 31, 2006. Oil

an after-tax basis, the reported loss included the $9.7 million write down

related to the company's ATM and merchant processing business

mentioned above that did not negatively impact tangible book value.

(Details related to amounts excluded from tangible book value are

provided in the attached Reconciliation of Non-GAAP Financial

Measures.)

182. The statements set forth in the above subsection were materially :false




Company and that the Company' s accounting for its mortgage business was

improper. In addition, it failed to disclose that the Company's tangible book value

was becoming worthless even with the restructuring due to the failure of the

Company's core businesses.

183. The February 21, 2007 announcement orNetBank's fourth quarter and

year end 2006 financial results also contained a section called "Management

Commentary" in which Defendant Herbert told investors that "in the span of 90

-105-


days," NetBank was able to "substantially execute a restructuring plan designed to

stabilise the company's operating profile and capital position," and that the Company

had .finally "emerged" from the "tunnel" of the restructuring having moved closer to

NetBank's goal ofrestoring profitability and stabilizing book value.The press release

stated, in part:

"I'm proud of the fact that, in the span of 90 days, we were able to

substantially execute a restructuring plan designed to stabilize the

company's operating profile and capital position. During the quarter, we

sold, exited or shut down our non-conforming mortgage operation; our

RV, boat and aircraft financing business; FTI and the QuickPost service;

and Netlnsurance. We consolidated two of our indirect conforming

mortgage operating centers into our Columbia facility, and during

December, we substantially effected a shut down of our auto lending

unit.

The final item remaining to be checked off our 'to do' list is the

completion of the sale of our ATM and merchant processing business.

We have a non-binding letter of intent in place and we are optimistic

that a definitive agreement will be reached soon and the deal will close

by the end of the first quarter. T am also pleased that we can check off

'engage an audit firm' which wasn't on our original list of things to do.

"When we began this process, T likened it to driving through a tunnel.

We had a roadmap, but we went in not knowing exactly what things

would look like on the other side. Now that we've emerged, were

evaluating our next steps.

"I'd be remiss if I didn't thank our associates for all the hard work they

-IO6-


have done since last October. That work has moved us closer to our goal

ofrestoring profitability and stabilizing book value . While we evaluate

our next steps , our operating priorities will continue to be moving our

indirect conforming mortgage operation back toward breakeven as

quickly as possible and generating cost-effective deposit growth at the

bank."

184. As a result of this news and NetBank's reassurances, the Company's

stock price rose from $3.57 per share on February 20, 2007 to $3.62 per share on

February 21, 2007.


and misleading because far from successfully executing a plan that "stabilize[d] the

company's operating profile and capital position" or "emerg[ing]" from the "tunnel"

of the restructuring, Defendants failed to disclose that the Company's financial

distress was due to the failure of its core operations, that selling off parts of its

mortgage business or other non-core operations would not be enough to resuscitate

the Company and that the Company's accounting for its mortgage business was

improper. In addition, it failed to disclose that far from "stabilizing book value," the

Company's tangible book value was declining rapidly even with the restructuring and

cash infusion due to the failure of the Company' s core businesses.

186. On March 23, 2007, NetBank filed a Form. 8-K with the SEC, which was

-107-


signed by defendant Gross and which attached a press release of the same date. That

attached press release announced that on March 20, 2007, the Company had received

a letter from the NASDAQ stating that NetBank's inability to file timely the 2006

Form 10-K served as a basis for its stock to be delisted. NetBank thereby further

perpetuated the falsehood that the only reason. For its failure to timely file the

Company's 2006 Form 10-K was the delay in retaining new independent auditors

after the resignation of E&Y. In the press release NetBank:

announced that on March 20, 2007, it received a staff determination

notice from the Nasdaq Stock Market stating that the company's

common stock is subject to delisting.

As previously reported, the company was unable to timely file its 10-K

due to the delay in engaging a new independent auditor after its former

independent auditor resigned effective 1'ovem.ber 9, 2006. On February

15, 2007, the company reported that it engaged Porter Keadle Woore,

LLP ("PKM") to replace Ernst & YoungLLPas its independent auditor.

The company currently believes that the 2006 audit, and related auditor

attestation regarding the companys internal control over financial

reporting, will be completed in June 2007 and expects to file its 10-K

with the SEC on or before June 30, 2007, although no assurance can be

given.

187. On this news, NetBank's stock price rose slightly from $2.41 per share

on March 23, 2007 to $2.42 per share on March 26, 2007, the next trading day.

-108-


188. On May 14, 2007, NetBank received an additional NASDAQ "Notice

of Non-Compliance" advising the Company of an additional basis for the del i sting

of the Company's common stock.

189. On May 15, 2007, NetBank issued a press release and a Form. 8-K,

signed by defendant Gross, in which it announced that it had received a letter from

the NASDAQ stating that while the Company had released preliminary unaudited

results for the December 31, 2006 year, the year-end statements would remain open

to "additional evidence with respect to conditions that existed at the date of the

balance sheet and affect estimates inherent in the process of preparing the audited

financial statements," and for the first time indicated that this may require NetBank

to "push back" and record certain unidentified "subsequent events" in its year-end

financial statements . In relevant part, the Netl3ank press release stated:

As previously announced, the company received a similar letter on

March 20, 2007, when it was unable to timely file its Annual Report on

Form 10-K for the fiscal year ended December 31, 2006 (the "10-K").

In response to that letter, the company requested, and was granted, a

hearing before a NASDAQ Listing Qualifications Panel. The hearing

was held on. May 3, 2007. During the hearing, the company presented

its plan for regaining compliance. Since the company is unable to file

its I0-Q before its 10-K has been filed, management currently expects

to file the 10-K and IO-Q concurrently on or before June 30, 2007,

although no assurance can be given.

-109-


The company also announced that it will delay reporting its results for

the quarter ended March 31, 2007, until its auditors have completed the

audit of the company's financial statements for the year ended December

31, 2006, and the company has filed the 10-K. While the company

reported preliminary, unaudited results for its year ended December 31,

2006, the subsequent events period applicable to our financial

statements for the year ended December 31, 2006, will remain open until

the completion of the audit. Under applicable accounting

pronouncements, events that occur or information that becomes

available subsequent to the December 3.1, 2006, balance sheet date but

before issuance of the year-end audited financial statements that

provide additional evidence with respect to conditions that existed at the

date ofthe balance sheet and affect the estimates inherent in the process

ofpreparing the auditedfinancial statements would be required to be

"pushed back " and recorded in the year-end ,financial statements. The

company currently expects that it may be required to "push back" and

record in its year-end financial statements certain subsequent event

items in accordance with these accounting pronouncements. However,

until the subsequent events period is closed, the company will not be in

a position to review or quantify such charges or their effect o its

previously reported preliminary, unaudited results at year-end. Upon

reporting final year-end and first quarter results, the company will

identify the nature and amount ofcharges, if'any, that were required to

be pushed back to 2006.

As previously reported, the company was unable to timely file its 10-K

due to the delay in engaging a new independent auditor after its former

independent auditor resigned effective November 9, 2006. On February

15, 2007, the company reported that it engaged Porter Keadle Moore,

LLP ("PKM") to replace Ernst & Young LLP as its independent auditor.

190. On this news, NetBank's stock price dropped slightly from $1.95 per

-110-


share on May 15, 2007 to $ I.90 per share on May 1. 6, 2007.



2006 Form 10-K was not due to a substantive issue, but rather was merely the

procedural result of not being able to engage an auditor in time to file. These

statements omitted to state that in fact, the reason for the failure to timely file was the



192. According to a confidential witness who was a senior executive of


defendants Freeman, Herbert and Gross, although PKM conducted a 2006 full-year

audit, the SEC would not accept the PKM full-year 2006 audit unless E&Y approved

it and reissued its prior certifications, which E&Y continually refused to do.

193. According to another confidential witness who was a senior executive

of NetBank during the entire Class Period and who interacted daily with Herbert,

Freeman and Gross, E&Y's continued refusal was a contributing factor to the demise

of NetBank. The Defendants were aware that if E&Y refused to certify NetBank's

-311-


financials, making it impossible for NetBank to file Financial statements with the

SEC, the Company's stock would eventually be delisted. E&Y continued to refuse

to certify NetBank's financials. As a result, the Company was assessed penalties by

the FDIC for a lack of timely audit, which ultimately led to the Company's stock

being delisted. The Defendants also knew and understood that if the NetBank lost its

SEC certification the Company could not maintain its WLC which, as alleged above,

was. essential to the continuation of its subprime mortgage operations at Meritage.

194. In the midst of making materially false and misleading statements

regarding its failure to timely make required filings with the SEC, NetBank continued

to sell off assets in an effort to raise capital, many of which were crucial to its core

operations.

195. On May 1, 2007, NetBank issued a press release in which it announced

that it sold. its ATM and Merchant Servicing Operation for $18 million, which

included initial cash proceeds of $16.5 million. Defendant Herbert portrayed this sale

as a "win-win" that would increase NetBank's tangible assets and tangible book value

even though he admitted that "NetBank was carrying the assets on its balance sheet

at a higher value than the sales price" and, therefore, the Company would "record an

additional impairment charge of approximately $2.0 million to bring the book value

-112-


of the assets into line with the sales price." More fully, the press release stated, in

part:

NetBank Payment Systems sold its principal operating assets and net

working capital yesterday to PAT ATM Services, LLC, a subsidiary of

Payment Alliance International, Inc. ("PAT"). The assets consisted

primarily of servicing contracts on more than 8,500 ATMs nationwide.

The sales price for the assets totaled S18.0 million, resulting in initial

cash proceeds of $1.6.5 million after adjustment for the estimated book

value of the net working capital acquired.

NetBank was carrying the assets on its balance sheet at a higher value

than the sales price. The bank will therefore record an additional

impairment charge of approximately $2.0 million to bring the book

value of the assets into line with the sales price. It is important to note

that the ATM servicing contracts were recognized on the bank's balance

sheet as intangible assets. Through the sale, the bank monetized them

and thus converted them from an intangible into a tangible. This means

the bulk. of the cash proceeds represents new tangible capital that

management can put to work in additional asset growth at the bank or

other cost-saving initiatives. It also directly increases the company's

overall tangible book value.

"We mentioned several months ago our intention to sell this operation

as part ofour larger corporate reorganization ofjbrt," said Steven F.

Herbert, ChiefExecutive Officer ("CEO"), NetBank, Inc. "We said then

that the operation was well managed and had real value. But, it simply

did not fit in with our core banking and mortgage focus. It required

significant capital to operate and therefore represented a strain or

distraction on our resources."

"The deal with PAT is a win-win proposition," Herbert concluded. "PAT

-113-


will be able to invest more in the operation and preserve the jobs of thetalented team we had in place. In turn, we have generated significant

new tangible capital. This money will prove important in our effort tomaintain proper regulatory capital ratios and to protect shareholder

value as we fight to get the company back on track financially throughfurther restructuring or other alternatives."

196. On these reassurances to the market that NetBank actually had increased

its tangible book value in this further stage of the restructuring, the Company's stock

price rose from $1.96 per share on May 1, 2007, to $2.07 per share on May 2, 2007.

197, The statements set forth in the above subsection were materially false

and misleading because far from being a "win" for NetBank that generated additional

capital for turning around the Company, as Defendants well-knew, no amount of

additional funding would save the Company since its financial distress was so deeply

rooted in the failure of its core operations and that its 2004 and 2005 financial

statements were false and misleading and could not he relied upon by the investing

public. In addition, it failed to disclose that the Company's tangible book value in fact

continued to decline rapidly even with the restructuring and multiple cash infusions

due to the failure of the Company's core businesses.

-114-

Case 1:07-cv-02298 -BBM Document 35-2 Filed 07/03/2008 Page 42 of 73

F. NetBank Misleads Investors Regarding the Validity

of Its FAS 133 Accounting

198. From at least March 16, 2005 through November 9, 2006, NetBank

issued financial reports that were materially false and misleading, primarily due to its

failure to comply with Statement of Financial Accounting Standard ("SFAS") 133.

The misrepresentations had the result of achieving management's desire to mask the

fact that its revolutionary business model implemented through, in substantial part,

its non-conforming mortgage loan business, was a sham.

199. In June 1998, the FASB released SFAS 133 which required that, after

January 1, 2001, derivatives be accounted for at fair market value. The standard

essentially provides that derivatives must be revalued every reporting period, and

changes to value must be reported in the income statement. To achieve hedge

accounting in compliance with SFAS 133, a company must associate each derivative

contract with the specific liability, asset or forecasted transaction being hedged.

200. The Financial Accounting Standards Board issued Statement ofFinancial

Accounting Standards ("SFAS" or "FAS") No. 133 in June of 1998. SFAS 133

governs "Accounting for Derivative Instruments and Hedging Activities." SFAS 133

establishes accounting and reporting standards for derivative instruments, including

-115-


certain derivative instruments embedded in other contracts, (collectively referred to

as derivatives) and for hedging activities. SFAS 133 was issued because the effects

of the increasing quantity and variety of derivatives used by companies were not

transparent in the financial statements. SFAS 133 standardizes the accounting

treatment for derivative instruments by requiring all. entities to report derivatives as

assets and liabilities on the balance sheet at their fair value.

201. Under SFAS 133, if certain conditions are met, a derivative may be

specifically designated as: (a) a hedge of the exposure to changes in the fair value of

a recognized asset or liability or an unrecognized firm commitment; (b) a hedge ofthe

exposure to variable cash flows of a forecasted transaction; or (c) a hedge of the

foreign currency exposure ofa net investment in a foreign operation, an unrecognized

firm commitment, an available-for-sale security, or a foreign-currency-denominated

forecasted transaction.

202. NetBank did not have or maintain the systems or personnel necessary to

perform and generate the foregoing reports to assess the reliability of the Company's

financial derivatives activity . Moreover, had NetBank properly applied GAAP, i.e.,

correctly applied the traditionally more well recognized. and accepted regression

methodology, the Company risked the revelation that it had overly relied upon non-

-116-


conforming mortgage loans to disguise weaknesses in its core banking segment.

203. By failing to comply with the requirements of FAS 133, NetBank failed

to qual ify for hedge accounting . This failure resulted in the Company publicly i ssuing

materially false and misleading financial statements for the periods covering fiscal

years 2004 and 2005. Although E&Y provided unqualified audit opinions for those

years, E&Y later refused to re-issue its 2004 and 2005 audit opinions for inclusion

in the 2006 Form 10-K until NetBank resolved the SEC's comments regarding the

Company ' s application of FAS 133 in accounting for the Company's mortgage

servicing rights and loans held for sale. The vast majority of previously reported net

income is a result of NctBank's improper hedge accounting.

204. In the prospectus, NetBank also claimed that "SFAS 133 is effective for

all fiscal quarters of fiscal years beginning after June 15, 1999." However, NetBank

claimed that "[t]he adoption of SFAS 133 is not expected to have a significant effect

on our financial statements."

205. It its 2005 Annual Report issued on or about March 15, 2006, NetBank

explained that:

NetBank's portfolio of derivatives which are designated and qualify ashedges are accounted for per the guidance set forth in SFAS 133, as

-117-


amended. As such, the Company tests the fair value hedges related to its

mortgage loans held for sale and mortgage servicing rights at inception

and on an ongoing basis to determine that the derivatives are highly

effective in offsetting changes in fair values or cash flows of the

respective hedged items. Gains and losses on derivatives hedging

servicing assets are included in other income, and gains and losses on

derivatives hedging mortgage loans held for sale are included in gains

on sales of loans and mortgage servicing rights.

If a derivative fails to meet hedge effectiveness tests, if hedge

designation for a derivative is discontinued, or if the asset or liability

being hedged is disposed of, the derivative is marked-to-market through

the statement of operations and included in other income. The amount

ofhedge ineffectiveness was not material,fc)r the years 2005 and 2004.

Derivatives not designated as either fair value or cash flow hedges are

marked-to-market through the statement of operations and included in

gain (loss) on derivatives with the offsetting entry to other assets or

liabilities.

206. During the relevant period NetBank attempt to conceal its failure to

comply with SFAS 133 by lobbying the SEC to reduce disclosure obligation with

respect to its application. For example, NetBank provided comments to the SEC

regarding the disclosures required pursuant SFAS 133, which it claimed were "overly

burdensome." Discussing Netbank's arguments against additional disclosures under

SFAS 133, the SEC wrote:

Netbank Inc. summed up its arguments against additional disclosures by

stating, "If one of the intended benefits of the proposed accounting

standard is to provide companies relief from the documentation and

-118-


paperwork requirements of FAS 133, the existence of paragraph (3)(e)

may very well put in place a documentation and paperwork requirement

that is equally onerous. In drafting the final rule under (3), we ask that

the FASB keep the documentation and disclosure requirements as

simple as possible."

207. On March 15, 2006, Defendants filed NetBank's Form 10-K for the

fiscal year ended December 31, 2005. That filing discussed NetBank's hedging

activities and application of FAS 133 under GAAP accounting, including inter a/ia:

The Company utilizes hedge accounting treatment for its servicing rights

under SFAS 133. If changes in. the value of the servicing rights and the

hedges meet certain hedge effectiveness criteria, changes in the fair

value of the servicing rights may be offset in the income statement by

changes in the fair value of the hedging instrument . Under SFAS 133,

as amended, the hedges are marked-to-market through the income

statement as other income.

208. On August 31, 2006, NetBank received an initial comment letter from

the SEC Staff regarding the Company's Form 10-K for the fiscal year ended

December 31, 2005 as filed on March 15, 2006.

209. The SEC' s comment letter questioned NetBank ' s application of

Financial Accounting Standards Board Statement of Financial Accounting Standards

No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS

133"), to the accounting of its mortgage servicing rights and loans held for sale.

-119-


Under SFAS 133, NetBank performed its hedge effectiveness assessments using a

statistical analysis approach other than regression. However, the SF..C questioned

whether NetBank's method of assessing hedge effectiveness was reasonable in the

circumstances and asked the Company to perform extensive supplemental analysis

to demonstrate the reasonableness ofNetBa.nk's method in comparison to a regression

methodology. Although NetBank was purporting to largely exit the lines of business

to which the SEC 's comment letters related , those lines formed a signi fi cant portion

of the Company's business in 2004 and 2005 which drove, in part , the value of the

Company at those times. The Individual Defendants knew that if the Company were

required to apply a different method of assessing hedge effectiveness it would

necessarily require a restatement of, at least, the Company's financial results as

audited by E&Y for the years 2004 and 2005 and could spell financial ruin for

NetBank. Notwithstanding the materiality of this information to investors, NetBank

failed to disclose these issues and allowed the investing public to continue to

purchase and hold the stock on the belief that the Company's prior financial results

were accurate.

210. Despite the severity of the potential consequences of the August 31,

2006, SEC letter and E&Y's reservations, NetBank did not reveal the existence ofthe

-120-


SEC letter until almost one year later on July 18, 2007. Those revelations were made

long after NetBank had failed to file financial results for 2006 in the wake of E&Y's

continuing refusal to re-issue its audit report covering the consolidated financial

statements of the Company for the years ended December 31, 2004 and 2005, for

inclusion in the 2006 Form 10-K.

211. On July 18, 2007, NetBank filed a Form 8-K with the SEC, signed by

Defendant Gross, in which it revealed for the first time that for nearly a year it had

been under SEC scrutiny regarding its SFAS 133 accounting. Thus, in the Form 8-K,

NetBank revealed:

On August 31, 2006, we received an initial comment letter from the SEC

Staff regarding the Company's Annual Report on Form 10- K for the

fiscal year ended December 31, 2005 (the "2005 Form 10-K"), to which

the Company provided an initial response. Subsequently, the Company

received follow-up and additional comment letters from the SEC Staff

relating to the 2005 Form l0-K and the Company's Quarterly Reports

on Form 10-Q for the quarters ended March 31, 2006, June 30, 2006 and

September 30, 2006. The Company has provided responses to all

subsequent letters. However, as of the date of this Current Report on

Form 8-K, certain comments remain unresolved as the Company and the

SEC Staff continue to review and discuss the Company's application of

Financial Accounting Standards Board Statement of Financial

Accounting Standards No. 133, Accountingfbr Derivative Instruments

and Iledging Activities ("SFAS 133"), to the accounting of its mortgage

servicing rights and loans held for sale.

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212. In the same Form 8 -K, NetBank also revealed that E&Y had formally

advised the Company that it would not re-issue its audit report covering NetBank's

consolidated financial statements for the years ended December 3 l , 2004 and 2005,

for inclusion in the 2006 Form 10-K. E&Y also indicated that it would not re-issue

such audit report for inclusion in the 2006 Form 10-K until the Company has resolved

with the SEC, the SEC's comments with respect to the Company's application of

SFAS 133 to the accounting of mortgage servicing rights and loans held for sale.

213. A component of the E.&Y audit was the provisions of FAS 133 which

E&Y established for NetBank in 2002. Each year, over the several years, E&Y

changed their interpretation ofhow NetBank should comply with FAS 133, and each

time, required NetBank to conduct additional analysis of previous years' accounting

before E&Y would sign off on their full-year financials. The area in question

pertained to the effectiveness of NetBank's hedging against loans.

214. In 2006, E&Y said that NetBank had to re-calculate its loan hedge-

effectiveness on a daily analysis basis for the years 2005 and 2006, long after the

hedges were in place . As a result of the increasing demands by E&Y, in 2006,

NetBank CEO Steve Herbert exploded during a conference with the E&Y auditors

over why they wanted NetBank to change the way they complied with FAS 133 each

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year. As a result of this disagreement , among other things, E&Y withdrew as

NetBank's auditors..A.l though they had been paid for the full years' 2006 audit, E&Y

would not sign off on NetBank's 4" Quarter 2006 financials and would not provide

their sign off for the 2006 full-year audit.

X. THE TRUTH REGARDING DEFENDANTS' FRAUDBEGINS TO EMERGE

215. The fact that Defendants had significantly misrepresented NetBank's

financial results, operations and condition in order to defraud investors did not

become known on a single day. Rather, the truth about Defendants' fraud and

NetBank's true financial condition began to emerge on May 21, 2007, and continued

through the time of its ultimate demise, representing the largest bank failure in the

United States in 14 years and beyond. Because NetBank has not filed its audited

financial statements for 2006 and E&Y has refused to re-issue its 2004 and 2005

audit report, the true extent of the fraud remains unknown. Although the truth

regarding the Defendants' fraud began to emerge on May 21, 2007, the truth

regarding NetBank's deteriorating financial condition, which was a direct and

proximate result of Defendants' fraud, began prior to the end of the Class Period on

May 21, 2007. The truth regarding NetBank' s true financial condition emerged in a

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series of partial disclosures throughout the Class Period. For example, an aspect of

truth regarding NetBank's true condition, but not the truth of the Defendants' fraud,

was partially disclosed on November 9, 2006, when the Company revealed that Ernst

& Young had resigned as its auditor. Aspects of the truth about NetBank's financial

condition, but not the truth of the Defendants' fraud, were partially disclosed on

February 21, 2007, when the Company announced its preliminary unaudited results

for the year ended December 31, 2006, having recorded an after-tax loss of $86.3

million or $1.86 per share during the fourth quarter.

A. First Disclosure of Regulatory Issues

216. On May 21, 2007, NetBank issued a press release in which it announced

that it had been forced to sell. core assets, outside the context of the restructuring, in

order to cover its bank deposit obligations. Yet, these assets were the very assets that

NetBank's restructuring was intended to preserve. However, the sale was not

voluntary. Rather, as the Company disclosed for the first time, it had been compelled

by banking regulators who "advised" NetBank management to find an "alternative"

to the restructuring to shore up NetBank's "capital and earnings trends" "immediately

[to] cover all of the bank's deposit obligations."

- t 24-


217. For the first time, NetBank's May 21, 2007, announcement

acknowledged that many of the problems it faced were not due to the "weakened

fundamentals of our core businesses." In effect, NetBank had thus revealed that its

efforts to enter new business segments by leveraging its core business was a failure

and that the initial appearance that that strategy had been positive was premised upon

the Company's false and misleading financial statements for the years 2004 and 2005

prepared by E&Y. Yet, even then, NetBank did not reveal that it had been under

intense scrutiny from the SEC. Rather, NetBank claimed only that it had been under

extreme financial pressure for more than a year mainly due to a difficult mortgage

origination market and a flat yield curve. The Company claimed that those pressures

resulted in large operating losses that significantly reduced the company's capital

position.

218. According to a confidential witness who was a senior executive officer

of NetBank during most of the Class Period, and who had direct daily contact with

the top executive officers, the Defendants were aware at least as early as the time

banking regulators became involved in the direction of the Company that ifNetBank

could not be sold, it would fail.

219. Despite the long overdue acknowledgment by NetBank on May 21,

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2007, according to a confidential witness who was a senior corporate officer of

NetBank during most of the Class Period, and who provided input directly to

defendants Freeman, Herbert, and Gross, as early as the third quarter of 2006, the

De.Cendants were aware that a sale ofthe entire Company was necessary. Accordingly,

NetBank and the Individual Defendants attempted to merge or sell NetBank at least

twice before the EverBank transaction was pursued. Specifically, in September, 2006,

NetBank held discussions with First Horizon which quickly failed once First Horizon

conducted its due diligence of NctBank.

220. Ultimately, in response to pressure from regulators, NetBank sold, at a

loss ofbettiveen $60 to $ 70 million : $2.5 billion of the Company's core and brokered

deposits; NetBank's held for investment loan portfolio; all ofthe assets and liabilities

ofNetBank Business Finance , the Company' s small business equipment leasing and

financing operation; and the NetBank brand and related trademarks and service

marks. In its May 21, 2007 press release, NetBank:

announced that the bank has executed an asset purchase and liability

assumption agreement with EverBank, an FDIC-insured, federal savings

bank and subsidiary of EverBank Financial Corp., a privately held

financial services holding company headquartered in Jacksonville, Fla.,

with approximately $4.7 billion in assets. The purchase price represents

a discount to the current carrying value ofthe assets and liabilities being

conveyed, and NetBank anticipates recording a loss on sale of between

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$60 and $70 million at close.

The transaction is expected to close by the end of June 2007, subject to

regulatory approval, and relates to the broader initiative the company

began earlier in the year to consider strategic alternatives that would

allow management to serve the interests of its customers, while

protecting the company's equity position from continued erosion.. The

company has been under extreme financial pressure for more than a year

due to a difficult mortgage origination market, a flat yield curve

environment and other factors. These pressures have resulted in large

operating losses that have significantly reduced the company's capital.

position and prompted heightened regulatory oversight.

NctBank worked closely with regulators as it evaluated various

opportunities. Regulators have been increasingly concerned about the

bank's capital and earnings trends and advised management to find an

alternative immediately that covered all of the bank's deposit

obligations.

The primary assets and liabilities in the transaction include:

The bank's held for investment loan portfolio;

* All of the assets and liabilities of NetBank Business Finance, the

bank's small business equipment leasing and financing operation;

* The bank's $2.5 billion in core and brokered deposits; and

* The NetBank brand and related trademarks and service marks.

Management Commentary

"In spite of our best efforts to improve the company's operating profile

through the restructuring plan we undertook last year, our company has

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remained very vulnerable and at risk due to the weakened,fundamentals

ofour core businesses," said Steven F. Herbert, chief executive officer,

NetBank, Inc. "Our mortgage operations continue to struggle in the face

of a highly competitive marketplace, especially the third-party

origination channel. Bank earnings have also fallen sharply as we have

had to de-leverage the balance sheet in order to maintain risk-based

capital ratios within appropriate regulatory guidelines.

"Our effort to manage and address these pressures was further

complicated by the delay of the annual audit and greater day-to-day

regulatory oversight and involvement.

"Our remaining businesses will include our mortgage servicing

operation, along with our retail prime mortgage franchise, Market Street

Mortgage," Herbert concluded. "We are actively evaluating their long-

term strategic alternatives as well as those of the parent company as a

whole. We have also retained our CMC claim. and the deferred tax asset

that we generated in the fourth quarter of 2006. After consummation of

the EverBank transaction, we will focus intensely on prosecuting the

CMC sureties and pursuing our claim against them, which we now

estimate at $150 million."

221. On May 21, 2007, defendants Herbert and Gross held a conference call

with analysts to discuss the Company's shocking revelations. On the call, Defendant

Herbert stated that "We sought and were unable to successfully pursue a transaction

for the entire company." He further explained that, "In the end, EverBank was the

only partner that stepped up with a plan that the regulators were prepared to seriously

consider." Herbert stated that after transitioning the deposit base to EverBank, the

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residual portions of the bank platform would need to be shut down at a cost of $26

million to $34 million. On the call Herbert also estimated that shareholders equity

dropped to $182 million from $229 million at the end of 2006. He forecast

shareholder equity would further decline to $50 million to $70 million after costs to

unwind the businesses that were being shut down or sold.

222. In response to this disastrous news, the market , shocked, reacted sharply

and swiftly. NetBank's stock price plummeted from $1.75 per share on Friday, May

18, 2007 to $0.59 per share on May 21, 2007 (the next trading day), a drop in price

of over 66% on massive volume of 1 1,190,400, which was over forty-five times the

volume of the previous trading day.

223. Undeterred , Herbert continued the charade that the failure to timely file

with the SEC was merely a "delay" rather than a substantive problem that threatened

the very continuation ofNctBank as a going concern and omitted that the Company's

accounting was under intense scrutiny from the SEC. Herbert stated:

Our effort to manage and address these pressures was

further complicated by the delay of the annual audit and

greater day-to-day regulatory oversight and involvement.

224. Herbert's statement remained materially false and misleading in that it

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falsely led investors to believe that the delay in filing the 2006 Form 10-K and First

Quarter 2007 Form I 0-Q was not due to a substantive issue , but rather was merely

the procedural result of not being able to engage an auditor in time to file. These

statements omitted to state that, in fact, the reason for the failure to timely file was the


and, through that, its tangible book value. Herbert's statements also omitted that the

Company was under intense scrutiny from the SEC regarding its FAS 133 accounting,

as alleged.

225. On May 22, 2007, as reported by the Associated Press, Paul J. Miller Jr,

an analyst with Friedman, Billings, Ramsey, said the net value of NetBank's assets,

which the bank then estimated at $25 million to $45 million, was "careening toward

zero." Based on the Company ' s May 21 , 2007 disclosure , Miller downgraded

NetBank to "Underperform" from "Market Perform" and cut his price target for

NetBank's common stock from $2.00 to $0.00. Analyst Christopher Marinac ofFIG

Partners LLC in Atlanta, dropped all coverage of NetBank as of that day.

226. In response to Miller's rating and the related news article, NetBank's

stock price fell a further 37%, from $0.59 per share on May 21, 2007 to $0.37 per

share on May 22, 2007.

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227. According to a confidential witness who was a NetBank officer

employed in the Corporate Fi Hance Department throughout the Class Period, and who

had direct dealings with top management including CFE Herbert, Defendants knew

that given NetBank's assets and liabilities the Company "could never close the

[F.verBan.k.] deal."

228. In addition to the fact that the Defendants independently knew that the

EverBank merger would not close based on the economic merits, Herbert also knew

that the transaction required approval by the OTS. However, at the time of Herbert's

May 21, 2007 statements, the work necessary to conduct the merger had not yet

begun. According to a confidential witness who was a senior corporate officer of

NetBank during most of the Class Period, and who provided input directly to

defendants Freeman, Ilerbert, and Gross, even as of June 2007 the parties were still

attempting to hire project leaders for the merger. According to that confidential

witness, the merger process had not begun because the parties lacked the necessary

personnel to complete the project.

229. On the May 21, 2007 conference call, defendant Herbert effectively

conceded that a sale of the entire Company was not a viable option because of the

status of the audit and lack of financials, and that simply delaying any sale was also

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not an option:

The OTS directed us to secure an immediate solution that enabled the

bank to meet all of those deposit obligations. I think they made it pretty

clear that if we did not soon resolve all the deposits , they would be

obligated to step in. And I think they also made it pretty clear that they

would not hesitate or delay to step in if needed.

So, we were unable to effectively pursue a transaction fi r the entire

company due to the status ofour annual audit. As you well know, we

don't have current financials and we couldn't secure a shareholder vote

because of the non-current nature of our financial statements.

So we were limited to fewer options and given the regulatory framework

that I just mentioned, waiting was not an option. Delay, we believed,

would have resulted in further capital erosion and probably or would

have brought to bear adverse regulatory actions.

230. Similarly, according to a confidential witness, who was a senior

executive of NetBank during the entire Class Period, and who had regular daily

interaction with defendants Freeman, Herbert and Gross, it was well known to

NetBank's management in March of 2007, that the Company would not survive.

Indeed, it was known and understood by the Defendants that the agreement reached

with EverBank would only provide sufficient capital to enable NetBank to shut down,

not to continue operations as Herbert claimed on the May 21, 2007 conference call.

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B. August 2007 Disclosure of Material Overvaluation

231. Long after NetBank's shocking revelations ofMay 21, 2007, additional

aspects of the truth continued to emerge; however, the damage was done and none

resulted in a material decline in the Company's stock price.

232. On August 6, 2007, NetBank filed a Form 8-K with the SEC in which

Defendants disclosed for the first time that one of the Company's core operations,

Market Street, NetBank's wholly-owned retail mortgage business, was not only

substantially overvalued in violation of GAAP, but was in fact worthless. As a result,

the Company took a non-cash impairment charge of approximately $24.6 million for

the impairment of goodwill assigned to Market Street where the carrying value of

Market Street was exactly the amount written off -- $24.6 million.

233. In the August 6, 2007 8-K, NetBank revealed that Market Street was

worthless and that its goodwill was impaired, a fact that Defendants claimed only to

have discovered when examining options to dispose of that entity:

Based on the information the Company obtained during the course of its

consideration of such other opportunities for Market Street, and the

likelihood of execution of one or more of such other opportunities, the

Company determined that an event indicative of impairment had

occurred with respect to Market Street.

-133-


As a result, the Company evaluated the carrying value of goodwill of

Market Street, and on August 2, 2007, authorized officers of the

Company concluded that a material impairment charge with respect to

the carrying value of goodwill assigned to Market Street is required

under GAAP. As a result, for the second quarter ending Tune 30, 2007,

the Company expects to record a non-cash impairment charge of

approximately $24.6 million (both pre-tax and after tax) for the

impairment of goodwill assigned to Market Street.

234. Ina Form 8-K filed on August 6, 2007, NetBank also disclosed that the

Office of Thrift Supervision ("OTS") had notified NetBank that it was

undercapitalized and was required to respond with a capital restoration plan no later

than September 13, 2007 that would satisfy applicable regulations . NetBank also

confinned that its stock had no value and was a "highly speculative" investment:

Due to NetBank's capital category and as provided in the Notice,

NetBank is subject to various restrictions, including limits on (i) capital

distributions; (ii) growth in total assets; (iii) acquisitions of new

companies or offices; (iv) engaging in any new lines of business; and

(iv) accepting, renewing or rolling over of brokered deposits.

As aresult ofthe Company's obligations under the Notice, the Companybelieves that its outstanding common stock may have little or no value.Accordingly, investment in the Company's common stock would behighly speculative.

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235. As ofAugust 7, 2007, having confrm.ed what many investors recognized

as a result of NetBank ' s shocking revelations on May 21 , 2007 - that NetBank's

outstanding common stock had little or no value and that any investment in the stock.

would be highly speculative - the jig was finally up. Indeed, NetBank's August 6,

2007 Form 8-K also disclosed that the NASDAQ, likely recognizing NetBank's

assurances that it would ultimately file its long awaited financial reports [or the farce

that they were, intended to delist the Company's common stock due to its continued

failure to file its 2006 Form 10-K, which NetBank had promised the investing public

as of June 30, 2007, and the First Quarter 2007 Form 10-Q. After NetBank's

purported June 30, 2007 target date passed, its August 6, 2007 Form 8-K was the final

confirmation that the Company could no longer continue the charade and that its late

filings were, in fact, the result of the Defendants ' failure to properly vat ue NetBank's

core businesses in accordance with GAAP.

236. On August 7, 2007, NetBank reiterated that despite the fact that it

expected to receive $19.25 million from the settlement oflong standing litigation, the

Company reiterated its August 6, 2007 warning that Netbank common stock was

worthless.

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237. On this news, NetBank's stock price doubled from $0.06 per share on

August 22, 2007 (on volume of 34,089 shares) to $0.12 per share on August 23, 2007

(on astounding volume of 6,294,574 shares).


and misleading because, in combination with the proposed sale of assets to EverBank,

this cash infusion falsely led investors to believe that the Company could now be in

compliance with OTS requirements.

C. The Disclosure of the Collapsed Everbank Agreement

239. On September 17, 2007, EverBank issued a press release in which it

announced: "that it ha[d] terminated its agreement to acquire NetBank's consumer

deposit accounts, business finance division and other assets under the transaction

announced on May 21, 2007, This decision comes after it became clear that NetBank

would not be able to complete certain conditions required to close and receive

regulatory approval."

240. NetBank's September 17, 2007 Form 8-K filed with the SEC announcing

the termination of the agreement stated that:

On September 14, 2007, the Bank received a letter from EverBank

notifying the Bank of EverBank's termination of the Purchase

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Agreement effective on September 14, 2007. EverBank's letter states

that NetBank is in breach of its representations and warranties as the

basis for its termination of the Purchase Agreement.

EverBank has not advised the Bank or the Company of any specifics

regarding the alleged breach. The Company and the Bank do not believe

that any breach has occurred. However, since the required regulatory

approvals were not received by August 3I, 2007, and since the Purchase

Agreement permits either party to terminate the Purchase Agreement

without cause after that date, neither the Company nor the Bank

presently contemplate contesting the termination. Instead the Company

intends to pursue such other strategic alternatives as may be available.

As a result of ongoing Financial and regulatory pressure, the Company

believes that its outstanding common stock may have little or no value.

Accordingly, investment in the Company' s common stock would be

highly speculative.

241. On September 28, 2007, NetBank, Inc. filed a voluntary petition for

relief under Chapter 1 I of the United States Bankruptcy Code in the United States

Bankruptcy Court for the Middle District of Florida, Jacksonville Division. The

Company announced that it would continue to operate as a debtor-in-possession

under the jurisdiction ofthe Bankruptcy Court. NetBank's failure represented the first

bank failure in five years, the largest ever in the State of Georgia and the largest in

the preceding 14 years.

242. On September 28, 2007, NetBank also announced that the Office of

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Thrift Supervision exercised its authority under applicable federal law to appoint the

Federal Deposit Insurance Corporation as receiver for NetBank, a federal savings

bank and a wholly-owned subsidiary of the Company.

243. In a September 28, 2007, press release, the OTS explained that:

The Office of Thrift Supervision (OTS) announced today that it closed

$2.5 billion NetBank, headquartered in Alpharetta, Georgia, and

appointed the Federal Deposit Insurance Corporation (FDIC) as

receiver.

A`etBank sustained significant losses in 2006 primarily due to early

payment defbulis on loans sold, weak underwriting, poor

documentation , a lack ofproper controls, and failed business strategies.

As a result, the OTS executed a formal enforcement action with

NetBank in 2006 directing the institution to correct its operating

deficiencies and enhance its capital position . While the institution

continued to operate in excess ofminimum capital standards , the actions

taken to address these problems were unsuccessful and it became clear

that high operating expenses combined with continuing losses were

jeopardizing the institution ' s viability.

In response, NetBank's board of directors undertook efforts to complete

a private sale of the institution. These efforts were unsuccessful and the

institution had no remaining prospects for raising capital and achieving

profitability. Accordingly, the OTS exercised its authority under the

Home Owners' Loan Act to appoint the FDIC as receiver of the

institution.

244. That same day, Eula L. Adams resigned as a member of the Board of

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Directors, of the Company. Mr. Adams' resignation was reportedly "not due to any

disagreement with the Company." Adams also resigned as a member of the Audit

Committee and Corporate Governance Committee of the Board effective September

28, 2007.

245. On October 1, 2007, EverBank announced that it successfully acquired

approximately $700 million of NetBank mortgage assets.

XX.. GAAP VIOLATIONS

246. As described above, the Defendants caused the Company to falsely

report its financial position and results of operations throughout the Class Period by,

among other things, overstating net earnings (or understating net losses, as

applicable) and misrepresenting the Company's true financial position. The

Company's 2004 and 2005 annual financial statements and. 2006 interim financial

statements for the first, second and third quarterly periods (collectively, the "relevant

financial statements") were not a fair presentation of the Company's financial

position and results of operations , and were not presented in conformity with GAAP

and SEC rules.

247. Generally Accepted Accounting Principles ("GAAP") are those

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principles recognized by the accounting profession as the conventions, rules, and

procedures necessary to define accepted accounting practices at a particular time.

GAAP principles are the official standards accepted by the SEC and promulgated in

part by the American Institute of Certified Public Accountants ("AICPA"). GAAP

consists of a hierarchy of authoritative literature . The highest priority is comprised

of Financial Accounting Standards Board ("FASB") Statements of Financial

.Accounting Standards ("FAS"), followed by FASB Interpretations ("FIN"),

Accounting Principles Board Opinions ("APB"), and AICPA Accounting Research

Bulletins ("ARB"). GAAP provides other authoritative pronouncements including,

among others , the FASB Concept Statements ("FASCON").

248. As a publicly traded company during the Class Period, NetBank was

responsible for and required to maintain books and records in sufficient detail to

reflect the transactions of the Company and, therefore, prepare financial statements

in accordance with GAAP. Specifically , the Exchange Act, 15 U.S.C. § 78m (b) (2),

requires public companies to:

(A) make and keep books, records, and accounts, which, in reasonabledetail, accurately and fairly reflect the transactions and dispositions ofthe assets of the issuer; and

-140-


(B) devise and maintain a system of internal accounting controlssufficient to provide reasonable assurances that -

transactions are executed in accordance with

management's general or specific authorization;

H. transactions are recorded as necessary to permit

preparation of financial statements in conformity with

generally accepted accounting principles or any other

criteria applicable to such statements, and

iii. to maintain accountability for assets;

iv. access to assets is permitted only in accordance with

management's general or specific authorization; and

V. the recorded accountability for assets is compared with the

existing assets at reasonable intervals and appropriate

action is taken with respect to any differences.

249. SEC 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, despite footnote or other disclosure.

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

-141-


statements . (17 C.F.R. § 210.10-01(a)).

A. Lack of Ade uate Internal Controls

250. Despite repeated certifications and other public statements by

Defendants as alleged more fully herein, NetBank lacked effective disclosure controls

and procedures, and internal control over financial reporting. Absent proper controls

and procedures, the resulting Financial reporting may be materially false and

misleading . Indeed, NetBank's lack of adequate controls was so profound and

irreconcilable, the Company's independent auditor, E&Y, resigned effectively in

protest over this issue in. November 2006.

251. NetBank's 2004 Form 10-K, filed with the SEC on March 16, 2005 --

the opening ofthe alleged Class Period, reported that the Company's internal controls

had been found to be deficient, but assured investors that such deficiencies had been

corrected and would not recur:

Management's Conclusion on the Effectiveness of Disclosure

Controls and Procedures

The Company's Chief Executive Officer and Chief Financial Officer,along with other management of the Company, reviewed and evaluatedthe Company's disclosure controls and procedures (as defined in rule13a-15(e) under the Securities Exchange Act of 1934, as amended (the

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"Exchange Act")) as of December 31, 2004. Based on that evaluation,

the Chief Executive Officer and Chief Financial Officer ofthe Company

concluded that, as of December 31, 2004, the disclosure controls and

procedures in place at the Company were not effective due to a material

weakness in its internal control over financial reporting related to the

estimation of the change in fair value of the Company's portfolio of

mortgage loan funding commitments for which the interest rate is locked

("rate locks") which constitute derivative financial instruments as

defined by Statement of Financial Accounting Standards No. 133

("SFAS 133"), Accounting for Derivative Instruments and Hedging

Activities, as amended by Statement ofFinancial Accounting Standards

No. 149 ("SFAS 149"), Amendment of Statement 133 on Derivative

Instruments and Hedging Activities. The error would have resulted in an

overstatement ofthe mark-to-market ofthe derivatives which is included

in the gain on sale line item.

Due to this material weakness, the Company, in preparing its financial

statements at and for the year ended December 3 t, 2004, performed and

implemented the additional procedures discussed below under the

heading "Other Control Matters" to strengthen its controls and

procedures over the process. Due to the nature ofthe material weakness

and the additional procedures implemented, management believes the

circumstances which resulted in the error will not recur.

252. In that same 2004 Form 10-K, Defendants admitted their responsibility

for the Company's financial internal controls and further explained:

Management's Annual Report on Internal Control over Financial

Reporting

The management of NetBank is responsible for establishing andmaintaining adequate internal control over financial reporting (as

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defined in Rule 13a-15(f) under the Exchange Act). NctBank's internal

control system is designed to provide reasonable assurance to the

Company's management and Board of Directors regarding the

preparation and fair presentation of published financial statements.

An internal control material weakness is a significant deficiency, or

aggregation of deficiencies, that does not reduce to a relatively low level

the risk that material misstatements in financial statements will be

prevented or detected on a timely basis by employees in the normal

course of their work. An internal control signilcant deficiency, or

aggregation of deficiencies, is one that could result in a misstatement of

the fnancial statements that is more than inconsequential.

The management of NetBank assessed the effectiveness of the

Company's internal control over financial reporting as ofDecember 31,

2004, and this assessment identified a material weakness in the

Company's internal control over financial reporting related to its

controls over the determination and estimation of the change in fair

value of the Company's portfolio of mortgage loan funding

commitments where the interest rate has been locked and related

financial derivatives. Changes in such fair value are recorded to gain on

sales of loans and to other assets or other liabilities. As a result of this

material weakness, the Company had overstated its gain on sales of

loans and recorded an adjustment in the December 31, 2004 financial

statements to correct this error.

In making its assessment of internal control over financial reporting

management used the criteria issued by the Committee of Sponsoring

Organizations of the Treadway Commission (COSO) in Internal

Control-Integrated Framework. Because of the material weakness

described in the preceding paragraph, management believes that, as of

December 31, 2004, the Company's internal control over financial

reporting was not effective based on those criteria.

-144-


253. In that same 2004 Form 10-K, Defendants included a letter dated March

11, 2005 from NetBank's independent auditor, E&Y to the NetBank Board and the

Company's shareholders, which stated in pertinent part:

Report of Independent Registered Public Accounting Firm on

Internal Control over Financial Reporting

The Board of Directors and Shareholders of NetBank, Inc.

We have audited management's assessment, included in the

accompanying Management's Annual Report on Internal Control over

Financial Reporting, that NetBank, Inc. did not maintain effective

internal control over financial reporting as of December 31, 2004,

because of the effect of a material error that was not identified by

NetBank, Inc.'s internal control over financial reporting, based on

criteria established in Internal Control----Integrated Framework issued

by the Committee of Sponsoring Organizations of the Treadway

Commission (the COSO criteria). NetBank, Inc.'s management is

responsible for maintaining effective internal control over financial

reporting and for its assessment of the effectiveness of internal control

over financial reporting. Our responsibility is to express an opinion on

management's assessment and. an opinion on the effectiveness of

NetBank, Inc.'s internal control over financial reporting based on our

audit.

We conducted our audit in accordance with the standards of the Public

Company Accounting Oversight Board (United States). Those standards

require that we plan and perform the audit to obtain reasonable

assurance about whether effective internal control over financial

reporting was maintained in all material respects. Our audit included

obtaining an understanding of internal control over financial reporting,

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evaluating management's assessment, testing and evaluating the design

and operating effectiveness of internal control, and performing such

other procedures as we considered necessary in the circumstances. We

believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process

designed to provide reasonable assurance regarding the reliability of

financial reporting and the preparation of financial statements for

external purposes in accordance with generally accepted accounting

principles.

A company's internal control over financial reporting includes those

policies and procedures that (l) pertain to the maintenance of records

that, in reasonable detail, accurately and fairly reflect the transactions

and dispositions of the assets of the company; (2) provide reasonable

assurance that transactions are recorded as necessary to permit

preparation of financial statements in accordance with generally

accepted accounting principles, and that receipts and expenditures o Fthe

company are being made only in accordance with authorizations of

management and directors of the company; and (3) provide reasonable

assurance regarding prevention or timely detection of unauthorized

acquisition, use, or disposition of the company's assets that could have

a material effect on the financial statements.

A material weakness is a control deficiency, or combination of controldeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected. The following material weakness has beenidentified and included in management's assessment. There wereinsufficient controls over the determination and estimation ofthe changein fair value of the Company"s portfolio of mortgage loan fundingcommitments where the interest rate has been locked and the relatedfinancial derivatives. As a result of this material weakness in internal

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control, NctBank, Inc. concluded that the amount of gain on sales ofloans was overstated and recorded an adjustrn.ent to correct this error.This material weakness was considered in determining the nature,timing, and extent of audit tests applied in our audit of the 2004financial statements, and this report does not affect our report datedMarch 11, 2005 on those financial statements.

In. our opinion, management's assessment that NetBank, Inc. did not

maintain effective internal control over financial reporting as of

December 31, 2004 is fairly stated, in all material respects, based on the

COSO control criteria. Also, in our opinion, because of the effect of the

material weakness described above on the achievement of the objectives

of the control criteria, NetBank, Inc. has not maintained effective

internal control over financial reporting as of December 31, 2004 based

on the COSO control criteria.

254. In that same 2004 Form 10-K, Defendants also included a response as

to the identified material control weakness and provided these additional assurances

to investors:

In response to the material control weakness discussed above in


Reporting, management has taken the following steps to remediate the

control weakness:

• The necessary data and information for estimating the initial and

ending fair values are now accumulated within a single

department;

• Analytics are now being prepared which compare the changes in

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fair value to changes in the fair value of offsetting hedges andgeneral changes in interest rates to ensure results are reasonable;

The Company's corporate controller is now required to review the

process and associated analysis.

Management will continue to closely monitor the changes implemented

to ensure their effectiveness. Except for the changes discussed above,

there were no other changes in the Company's internal control over

financial reporting that have materially effected, or are reasonably likely

to materially effect, its internal control over financial reporting.

255. Similarly, the Company's Forms 10-Q for the first, second and third

fiscal quarters of 2005 (filed with the SEC on May 10, August 9 and November 14,

2005, respectively ) repeated Defendants " assurances that the Company' s controls

were operating effectively. In addition , each of those financial reports purported to

report the Company's financial condition as of the end ofthe respective fiscal quarter

and financial results for the fiscal quarter.

256. NetBank's 2005 Form 10-K, filed with the SEC on March 15, 2006 again

reported that the Company's internal controls had been found to be effective:

Management's Conclusion on the Effectiveness of Disclosure

Controls and Procedures

Evaluation of Disclosure Controls and Procedures. We evaluated the

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effectiveness of the design and operation of our "di.sclosure controls andprocedures," as defined in Rule 13a-15(e) under the Securities Exchange

Act of 1934, as amended (the "Exchange Act"), as of the end of theperiod covered by this report. This evaluation was done under thesupervision and with the participation of management, including ourchief executive ofl:icer ("CEO") and chief finance executive ("CFO").

x;E ;r^C

Objectives ofControls. Disclosure controls and procedures are designed

so that infonnation required to be disclosed in our reports filed under the

Exchange Act, such as this Annual Report on Form 10-K, is recorded,

processed, summarized and reported within the time periods specified

in the SEC's rules and forms. Disclosure controls and procedures are

also intended to ensure that such information is accumulated and

communicated to our management, including the CEO and CFO, as

appropriate to allow timely decisions regarding required disclosure.

Conclusions. Based upon the disclosure controls and procedures

evaluation, our CEO and CFO have concluded that as of December 31,

2005, our disclosure controls and procedures are effective to provide

reasonable assurance that the foregoing objectives are achieved.

Changes in internal Control over Financial Reporting. There were no

changes in our internal control over Financial reporting, as defined in

Rule 13a-15(t) under the Exchange Act, during the quarter ended

December 31, 2005 that have materially affected, or are reasonably

likely to materially affect, our internal control over financial reporting.

257. In that same 2004 Fonn 10-K, Defendants admitted their responsibility

for the Company's financial internal controls and further explained:

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Reporting

The management of NetBank is responsible for establishing and

maintaining adequate internal control over financial reporting as such

term is defined in Rule 13a-15(f) under the Exchange Act. Our internal

control over financial reporting is a process designed to provide

reasonable assurance regarding the reliability of financial reporting and

the preparation of financial statements for external purposes in

accordance with accounting principles generally accepted in the United

States of America.

Management, under the supervision and with participation of the CEOand CFO, has assessed the effectiveness of the Company's internal

control over financial reporting as ofDecember 31, 2005. In making this

assessment, management used the criteria set forth by the Committee ofSponsoring Organizations of the Treadway Commission (COSO) in

Internal Control-Integrated Framework. Based on management's

assessment and that criteria, management concludes that, as of

December 3 1, 2005, the Company's internal control over financial

reporting is effective.

258. In that same 2005 Form 10-K, Defendants included a letter dated March

13, 2006 from NetBank's independent auditor, E&Y to the NetBank Board and the

Company's shareholders, which stated in pertinent part:

Report of Independent Registered Public Accounting Firm on

Internal Control over Financial Reporting

The Board of Directors and Shareholders of NetBank, Inc.

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We have audited management's assessment, included in the

accompanying Management's.Annual Report on Internal Control over

Financial Reporting, that NetBank, Inc. maintained effective internal

control over financial reporting as of December 3 I , 2005, based on

criteria established in Internal Control-Integrated Framework issued

by the Committee of Sponsoring Organizations of the Treadway

Commission (the COSO criteria). NetBank, Inc.'s management is

responsible for maintaining effective internal control over financial

reporting and for its assessment of the effectiveness of internal control

over financial reporting. Our responsibility is to express an opinion on

management's assessment and an opinion on the effectiveness of the

company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public

Company Accounting Oversight Board (United States). Those standards

require that we plan and perform the audit to obtain reasonable

assurance about whether effective internal control over financial

reporting was maintained in all material respects. Our audit included

obtaining an understanding of internal control over financial reporting,

evaluating management's assessment, testing and evaluating the design

and operating effectiveness of internal control, and performing such

other procedures as we considered necessary in the circumstances. We

believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process

designed. to provide reasonable assurance regarding the reliability of

financial reporting and the preparation of financial statements for

external purposes in accordance with generally accepted accounting

principles. A company's internal control over financial reporting

includes those policies and procedures that (1) pertain to the

maintenance of records that, in reasonable detail, accurately and fairly

reflect the transactions and dispositions ofthe assets of the company; (2)

provide reasonable assurance that transactions are recorded as necessary

to permit preparation of financial statements in accordance with

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generally accepted accounting principles, and that receipts and

expenditures of the company are being made only in accordance with

authorizations of management and directors of the company; and (3)

provide reasonable assurance regarding prevention or timely detection

ofunauthorized acquisition, use, or disposition of the company's assets

that could have a material effect on the financial statements.

Tn our opinion, management's assessment that NetBank, Tnc. maintained

effective internal control over financial reporting as of December 31,

2005, is fairly stated, in all material respects, based on the COSO

criteria. Also, in our opinion, NetBank, Inc. maintained, in all material

respects, effective internal control over financial reporting as of

December 31, 2005, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public

Company Accounting Oversight Board (United States), the consolidated

balance sheets ofNetBank, Inc. as of December 31, 2005 and 2004, and

the related consolidated statements of operations, shareholders' equity,

and cash flows for each of the three years in the period ended December

31, 2005 and our report dated March 13, 2006 expressed an unqualified

opinion thereon.

259. On April 10, 2006, NetBank issued a press release via Business Wire

which stated in pertinent part that the Company:

[NetBank] is currently implementing the FRS RiskResolve solution as

the foundation of its Sarhanes-Oxley (SOX) compliance strategy. The

diversified financial services provider will utilize RiskResolve to

automate SOX testing and attestation in a single application in order to

streamline its compliance efforts and achieve greater transparency across

the enterprise. NetBank will also extend its use of the FRS solution

beyond compliance to enterprise operational risk management (EORM)

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during the next phased deployment of RiskResolve to the business unit

owners. Risk.R.esolve`s automated COSO approach will enableNetBank

to align risk assessments, controls and actions to its reporting procedures

throughout the organization and establish compliance and operational

risk management as sustainable business processes.

"The RiskResolve deployment is an important element of our on-going

SOX compliance strategy," said Joyce Bellows, Director of SOX and

Internal Controls, NetBank, Inc. "We believe that the solution is

uniquely qualified to give us unprecedented insight into our business

processes and risk scenarios, and to help ensure that our financial

reporting and disclosures are accurate and complete."

260. Similarly, the Company's Forms 10-Q for the first, second and third

fiscal quarters of 2006 (filed with the SEC on May 10, August 8 and November 9,

2006, respectively) repeated Defendants' assurances that the Company's controls

were operating effectively. In addition, each of those financial. reports purported to

report the Company's financial condition as ofthe end ofthe respective fiscal quarter

and financial results for the fiscal quarter.

261. E&Y's resignation as NetBank's independent auditor became effective

on November 9, 2006. Despite the representations of NetBank and E&Y, the

Company had a significant ongoing disagreement with NetBank regarding the

calculation of the Company's hedge effectiveness under FAS 133. Acknowledging

the weakness in its internal controls, NetBank revealed that E&Y had resigned, at

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least in part, because of the "the determination. and estimation of the change in fair

value of the Company's portfolio of mortgage loan funding commitments where the

interest rate had been locked ." NetBank also reported that (emphasis added): "[i]n

2005, the Company implemented certain changes to its internal controls to address

the material weakness over the Company's rate locks and determined that the

material weakness existing at December 31, 2004 was corrected."

262. NetBank's Form 8-K, filed November 9, 2006, which reported the

resignation of E&Y as the Company's auditor, also reported:

In the Company's Annual Report on Form 10-K for the fiscal year ended

December 31, 2004, which the Company Filed with the SEC on March

16, 2005, Management's Annual Report on Internal Control over

Financial Reporting stated, and E&Y's report on internal controls

reiterated, that because of the material weakness disclosed in those

reports, the Company's internal control over Financial reporting was not

effective as of December 31, 2004, based on the criteria set forth by the

Committee of Sponsoring Organizations of the Treadway Commission

in Internal Control - Integrated Framework. The material weakness in

those reports concerned the Company's controls over the determination

and estimation of the change in fair value ofthe Company's portfolio of

mortgage loan funding commitments where the interest rate had been

locked and the related financial derivatives ("rate locks"). In 2005, the

Company implemented certain changes to its internal controls to address

the material weakness over the Company's rate locks and determined

that the material weakness existing at December 31, 2004 was corrected.

263. On February 21, 2007, NetBank issued a press release via Business Wire,

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in which it claimed that:


attestation regarding the company's internal control over financial

reporting, will be completed in June 2007 and expects to file its Annual

Report on Form l 0-K for the 2006 fiscal year with the SEC on or before

June 30, 2007, although no assurance can be given.

264. On March 23, 2007, NetBank issued a press release via Business Wire,

in which it repeated certain statements regarding its internal controls contained in a

press release issued by the Company on February 21, 2007, reporting in pertinent part

that:


attestation. regarding the company's internal control over financial

reporting, will be completed in June 2007 and expects to file its 10-K

with the SEC on or before June 30, 2007, although no assurance can be

given.

265. E&Y' s sentiments were echoed by the SEC. On July 17, 2007, NetBank

revealed that beginning nearly a year earlier, on August 31, 2006, the Company had

begun to receive a series of letters from the SEC challenging the Company's

application of Financial Accounting Standards Board Statement of Financial

Accounting Standards No. 133, Accountingfor Derivative Instru ments and Hedging

Activities ("FAS 133"), to the accounting of its mortgage servicing rights and loans

-155-


held for sale. Specifically, NetBank revealed for the first time that nearly a year

earlier:

On August 31, 2006, we received an initial comment letter from the SEC'

Staff regarding the Company's Annual Report on Form 10- K for the

fiscal year ended December 31, 2005 (the "2005 Form 10-K"), to which

the Company provided an initial response. Subsequently, the Company

received follow-up and additional comment letters from the SEC Staff

relating to the 2005 Form I 0-K and the Company's Quarterly Reports

on Form 10-Q for the quarters ended March 3 1, 2006, June 30, 2006 and

September 30, 2006. The Company has provided responses to all

subsequent letters. However, as of the date of this Current Report on

Form s-K, certain comments remain unresolved as the Company and the

SEC Staff continue to review and. discuss the Company's application of

Financial Accounting Standards Board Statement of Financial

Accounting Standards No. 133, Accounningfor Derivative Instruments

and.HedgingActi vities ("SFAS 133"), to the accounting of its mortgage

servicing rights and loans held for sale.

266. E&Y refused to re-issue its audit opinion for inclusion in NetBank's

2006 Form 10-K until the Company resolved the SEC's issues with respect to the

Company's application oIFAS 133 related to the accounting of mortgage servicing

rights and loans held for sale. E&Y's refusal likely prompted NetBank's July 17,

2007 revelations. More that one year later, at the time of its collapse on September

28, 2007, NetBank still had not - nor has it ever -- resolved the SEC's issues or filed

audited financial results for 2006.

-156-


267. On September 27, 2007, The Wall Street Journal reported that the

collapse of NetBank was the largest U.S. banking failure in 14 years, observing in

sum that weak underwriting, a lack of internal controls and a late push into subprime

mortgage lending was the simple recipe for failure.

268. Ultimately, on September 28, 2007, the OTS announced in a press

release that it had taken the extraordinary act of closing NetBank and appointed the

Federal Deposit Insurance Corporation (FDIC} as receiver, explaining that (emphasis

added):

NetBank sustained significant losses in 2006 primarily due to early

payment defaults on loans sold, weak underwriting, poor

documentation, a lack ofproper controls, andfailed business strategies.

269. NetBank's lack of effective internal controls was also specifically cited

by in the OIG Audit Report as having led to the huge mortgage losses suffered by the

Company, which was in turn one of the significant causes of NetBank' s failure:

Ineffective Internal Controls Over Operations

Certain internal controls overNetBank's operations were ineffective. For

example, rather than monitoring or instituting triggers to curtail its

mortgage banking operations when economic conditions warranted such

restrictions, NetBank's strategy continued to emphasize increased loan

production, accomplished by lowering underwriting and documentation

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standards. Products such as "low-doe" and "no-doc" loans allowed

borrowers to obtain loans without demonstrating their ability to repay

the loan. In addition, underwriters reported to individuals who marketed

and sold loans, and sales personnel pressured underwriters to approve

loans.

Lowered underwriting standards led to poor loan quality, which led to

loan repurchases, which led to large losses. In 2006, NetBank

repurchased $ 1.82 million in loans that it had sold and ultimately booked

$78 million dollars in loss provisions associated with the repurchases.

The large losses resulting from loan repurchases significantly

contributed to NctBank's failure.

270. The responsibility for preparing the financial statements in conformity

with GAAP lies with the company's management. Specifically , defendant Herbert as

NetBank's CFE and CEO, at times relevant during the Class Period, was directly

responsible for ensuring that NetBank's financial statements were prepared in

conformity with GAAP. Similarly, as CEO of the Company at times relevant during

the Class Period, defendant Freeman was also responsible for. ensuring that

NetBank's financial statements were prepared in conformity with GAAP.

271. AICPA Auditing Standards § ("AU") 110 Responsibilities and

Functions off the Independent Auditor ("AU 110"), in relevant part, mandates

management's responsibility for preparing the financial statements in conformity with

GAAP as follows:

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The financial statements are management's responsibility ....

Management is responsible for adopting sound accounting policies and

for establishing and maintaining internal control that will, among other

things, initiate, authorize, record, process, and report transactions (as

well as events and conditions) consistent with management's assertions

embodied in the financial statements. The entity's transactions and the

related assets, liabilities, and equity are within the direct knowledge and

control of management.. ..Thus, the fair presentation of financial

statements in conformity with generally accepted accounting principles

is an implicit and integral part of management's responsibility.

(AU 110.03) (Footnote omitted.)

272. As alleged herein, prior to and throughout the Class Period, Defendants

caused NetBank to significantly expand. its involvement with non-conforming and

other non-traditional loans relative to its core business (subsequently "other non-

traditional" loans). NetBank"s expansion into the non-conforming and other non-

traditional loan markets, paired with materially inadequate and ineffective controls

and underwriting guidelines, exposed the Company to a significant concentration of

inherently high risk loans. That concentration, in combination with certain prevailing

market conditions, such as declining home values and increasing credit delinquencies

and defaults, impaired the Company's financial position and caused significant

declines in the Company's results of operations during the Class Period. However,

NetBank failed to timely recognize material known losses (i.e., impairments)

-159-


regarding significant increases, primarily because ofthe Company's exposure to non-

conforming loans, of certain liabilities relevant financial statements.

273. In addition to NetBank's failure to timely recognize material known

impairments, the Company's relevant financial statements also failed to timely

recognize known impairment losses regarding its non-conforming and other non-

traditional loan operations.

274. In addition to NetBank' s failure to timely recognize material known

impairment losses, as alleged above, the Company's relevant financial statements also

significantly overstated the value of certain n ort gage-related assets. As a result,

NetBank failed to timely recognize the losses related to the overstatement ofthe value

of certain of its mortgage related assets. The effect ofNetBank's failure to recognize

known material impairment losses and the overstatement of its mortgage related

assets artificially inflating net earnings.

275. As a result of the foregoing, NetBank lacked effective disclosure

controls and procedures, and internal control over financial reporting, despite

repeated certifications of certain Defendants and other statements to the contrary.

276. Further, the Company's relevant financial statements presented the

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Company's financial position and results of operations in a manner which, among

other things, also violated the following fundamental accounting principles:

(a) The principle that financial reporting should provide information thatis useful to present and potential investors and creditors and other usersin making rational investment, credit and similar decisions (I ASCON

1, ¶34);

(b) The principle that financial reporting should provide information

about the economic resources of an enterprise, the claims to those

resources, and the effects oftransactions, events, and circumstances that

change resources and claims to those resources (FASCON 1, ¶40);

(c) The principle that financial reporting should provide information

about an enterprise' s financial performance during a period. "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 ' and creditors ' expectations about future

enterprise performance, those expectations are commonly based at least

partly on evaluations of past enterprise performance." (FASCON 1,

¶42);

(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. "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." (FASCON 1, ¶50);

(e) The principle that financial reporting should be reliable in that it

-161-


represents what it purports to represent. That information should be

reliable as well as relevant is a notion that is central to accounting

(FASCON 2, ¶J58-59);

(f) The principle of completeness , which means that nothing material is

left out ofthe information that may be necessary to ensure that it validly

represents underlying events and conditions (FASCON 2, ¶79);

(g) The principle that financial reporting should be verifiable in that it

provides a significant degree of assurance that accounting measures

represent what they purport to represent (FASCON 2, ¶81); and

(h) The principle that conservatism be used as a prudent reaction touncertainty to try to ensure that uncertainties and risks inherent inbusiness situations are adequately considered . (FASCON 2, ¶¶95, 97).

277. Each of the improper accounting practices , misrepresentations and

omissions engaged in by Defendants , and discussed further herein, standing alone,

was a material breach of GAAP and/or SEC regulations.

B. Understatement of Representations and Warranties Liability

278. Defendants caused the Company to issue the relevant financial

statements, which failed to timely recognize known losses regarding significant

increases of certain liabilities - primarily because of the Company's exposure to non-

conforming loans.

-162-



Netl3ank during the entire Class Period, and who had regular daily interaction with

defendants Freeman, Herbert and Gross, defendants Herbert and Gross, at a

minimum, knew that the Company's underwriting guidelines were insufficient. As a

result, the reserves that NetBank knew or should have know were necessary, were not

established. Prior to 2005, NetBank's trend analysis for the previous 8-9 years

showed that the Company's reserves needed to be in the range or I and -3) basis points.

However, beginning as early as 2005, NetBank's analysis changed dramatically,

showing that the Company needed to increase its reserves to between 12 and 14 basis

points.

280. The NetBank Regional Operating Center (ROC) handled the

underwriting of the subprime loans for Meritage. Decisions for the sub-prime

underwriting were made by Doug Freeman, Russell Burdsall, NetBank Head of

Mortgage Operations , and William (Micky) Ross, the NetBank Chief of Sales and

Fulfillment. By early 2006, it became clear that the Meritage subprime lending was

heading in the wrong direction and as a result, the financial position ofNetBank was

so severely damaged that the Company was facing the threat of breaching the

minimum 10% capital ratio required of NetBank in a separate but undisclosed

-163-


agreement with the OTS.

281. Notwithstanding the Defendants' knowledge that NetBank's own

analysis indicated that its reserves were severely deficient, on August 3, 2005,

Defendant Herbert represented in a conference call with analysts: "I mean as soon we

become aware of a loan in a problem, we allocate reserves to it, based upon our

expected sales price."

282. As early as November 14, 2005, Defendant Freeman attempting to

distance the troubled loans at NetBa.nk from those in the industry, but recognizing

that the risks to lenders such as NetBank were increasing, stated that:

SY JACOBS: [I]s there any consistency between this group of loans

we're talking about, the $3.5 million and then the smattering of other

buybacks are having to do -- is there some industry trend developing

here where there is an increase in fraud and loan buybacks, and they

have to do with the petering out of the housing boom?

DOUG FREEMAN: There are no relationships between the process-

driven ones and this group of loans, but I will tell you that T think the

risk profile in the mortgage business is going up -- me and everybody

else in the industry has a lot of writings on that.

283. Similarly, during the same call, Herbert stated:

There are specific products that can cause a problem from time to time,

but a lot of what we're seeing in the industry now is that the whole loan

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buyers, which this was not the common practice for them are now going

through some changes, we believe, anyway, and becoming more

aggressive about putbacks.

We do feel that the current assumption set that we have, you know, as

we look at recent behaviors, more recent frequency behaviors, that the

frequency assumptions that we're making concern in the future are much

more consistent with recent experience and have sort of lined up and

trued up with them so we feel, in general, better about the overall level

of the reserves that we have and the probability that it will be more

predictive of the future than it's been here in the past several quarters.

284. Despite Freeman's acknowledgment of the increased risks in the

mortgage business, NetBank failed to adjust its reserves and risk management to

compensate.

285. At the same time, in addition to their stated belief in the increased risks,

according to a confidential witness who, during most of the Class Period, was senior

managerial executive of Meritage, the Defendants were aware of certain difficulties

with subprime mortgage underwriting guidelines which resulted in NetBank taking

back mortgages that it should not have been accepting.

286. The Company described its representations and warranties liability in the

Business section and Management ' s Discussion and Analysis of Financial position

and Results of Operations section ("MD&A") of its Form 10-K filed March :l 5, 2006

-165-


("2005 Form 10-K"), as follows:

We make representations and warranties in the ordinary course of

business to purchasers and insurers of our mortgage loans and the

purchasers of our mortgage servicing rights regarding compliance with

laws, regulations and program standards and as to accuracy of

information. We may become liable for certain damages or may be

required to repurchase a loan if there has been a breach of

representations or warranties. For example, for certain loan sale

agreements, we are liable to thepurchaser ofthe loans ifan underlying

borrower defaults on the first payments due or if the borrower prepays

the loan shortly after sale. (2005 Form 10-K p. 38) (Emphasis added.)

The majority of our non-performing loans held for sale consist of loans

which the Company has been required to repurchase under

representations and warranties provided to purchasers ofour loans. Once

a loan has been repurchased, it is generally resold at a loss. Upon

repurchase, the Company transfers reserves from its liability for

representations and warranties to a valuation reserve for repurchased

loans to record such loans at estimated net realizable value. (2005 Form

I OK p. 58) (Emphasis added.)

287. GAAP, specifically, FAS 140, Accountingfor Transfers and Servicing

of Financial Assets and Extinguishinents of Liabilities (a replacement of FASB

Statement No. 125) ("FAS 140"), required the Company to recognize liabilities

incurred in the sale of its loans at fair value . FAS 140 provides , in relevant part:

Upon completion of a transfer of assets that satisfies the conditions to

be accounted for as a sale..., the transferor (seller) shall:

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a. Derecognize all assets sold

b. Recognize all assets obtained and liabilities incurred in

consideration as proceeds ofthe sale, including cash, put

or call options held or written ( for example, guarantee or

recourse obligations), forward commitments ( for example,

commitments to deliver additional receivables during the

revolving periods of some sccuritizations ), swaps (for

example, provisions that convert interest rates from fixed

to variable), and servicing liabilities, if applicable...

C. Initially measure at fair value assets obtained and

liabilities incurred in a sale... or, if it is not practicable to

estimate the fair value of an asset or a liability, apply

alternative measures...

d. Recognize in earnings any gain or loss on the sale.

The transferee shall recognize all assets obtained and any liabilities

incurred and initially measure them at fair value (in aggregate,

presumptively the price paid). (FAS 140 ¶1 l) (Certain emphasis in

original and certain emphasis added.) (Footnote omitted.)

288. NetBank had an inventory of mortgages for which they maintained

servicing rights which was handled by the NetBank Treasury Group. In most cases,

NetBank's prime mortgages were sold to Fannie Mae and NetBank earned money by

retaining the servicing rights. Under FAS 133, NetBank was required to show its

hedge effectiveness and performed calculations in an attempt to do so. However,

-167-


according to a confidential witness who was a senior executive ofNetBank during the

entire Class Period and who had regular daily interaction with defendants Freeman,

Herbert and Gross, E&Y advised NetBank and its senior management that the

Company's hedge effectiveness testing under FAS 133 was not being conducted

frequently enough to be reliable and directed NetBank to perform the hedge-

effectiveness on a daily basis. E&Y also directed NetBank to re-calculate the hedge-

effectiveness for previous years back to 2002.



defendants Freeman, Herbert and Gross, NetBank was also in negotiations with the

SEC regarding the frequency with which it performed its hedge-effectiveness under

FAS 133. Ultimately, NetBank reached an agreement with the SEC in which the SEC

would permit NetBank to perform a re-calculation for one month out of each quarter

to demonstrate that the hedging was effective. However, E&Y refused to accept the

proposal claiming that it did not believe that it was adequate. For its part, NetBank

and its senior management, upon information and belief, refused to accept the

assessment of E&Y. On that basis, among others, E&Y resigned as the NetBank

auditors.

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290. FAS 5, A ccounting for Contingencies ("FAS 5 "), provides further

guidance regarding recognition of loss contingencies. FAS 5 provides, in relevant

part:

For the purpose of this Statement, a contingency is defined as an

existing condition, situation, or set of circumstances involving

uncertainty as to possible gain (hereinafter a "gain contingency") or loss

(hereinafter a "loss contingency") to an enterprise that will ultimately be

resolved when one or more future events occur or fail to occur.

Resolution of the uncertainty may confirm the acquisition ofan asset or

the reduction of a liability or the loss or impairment of an asset or the

incurrence of a liability. (FAS 5 ¶1) (Footnote omitted.)

An estimated loss from a loss contingency (as defined in paragraph 1)

shall be accrued by a charge to income if both of the following

conditions are met:

a. Information available prior to issuance of the financial

statements indicates that it is probable that an asset had

been impaired or a liability had been incurred at the date

of the financial statements. It is implicit in this condition

that it must be probable that one or more future events will

occur confirming the fact of the loss.

b. The amount of loss can be reasonably estimated. (FAS 5¶8) (Emphasis added.) (Footnotes omitted.)

29 1. Defendants failed to adequately consider known breaches of

representations and warranties and the related losses that were both probable and

-169-


reasonably estimable. As noted in the Company's 2005 Form 10-K and excerpted

above, the amount of the Company's repurchase obligation, and corresponding losses,

related to representations and wan-antics was in part dependent upon the amount of

early defaults . As of the establishment of the representation and warranties liability

at time loan sales, and subsequently, Defendants were aware, or should have been

aware, of the significant probability of substantive early defaults because the

Defendants were aware, or should have been aware, of the poor, and continually

deteriorating, credit quality of the non-conforming loans sold as Defendants

originated. or purchased, presumably following appropriate due diligence, such non-

conforming loans. As discussed in greater detail elsewhere herein, Defendants were

aware, or should have been aware, of certain prevailing market conditions, such as

declining home values and increasing credit delinquencies and defaults , which further

increased the probability of early defaults. Defendants were aware, or should have

been aware , that the Company's lax underwriting guidelines exposed the Company

to the significant probability of additional breaches of its representations and

warranties regarding the loans sold which were originated by the Company.

292. Defendants disregarded such indications of the Company's true losses

regarding its representations and warranties liability; however, Defendants were

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aware of increasing losses as early as 2003. The Company's representations and

warranties liability at the initial purchase of its non-conforming loan operations (part

of the Resource acquisition as discussed in greater detail elsewhere herein) was

determined to be inadequate in the year immediately following the year of the

acquisition. In the Company's 2003 Form 10-K, filed with the SEC March 1.2, 2004,

Defendants disclosed that the purchase price allocation had to be adjusted for

additional representations and warranties liability. The 2003 Form 10-K reported:

The Company recorded a $2.9 million purchase accounting adjustment

due to certain pre-acquisition contingencies related to representations

and warranties related to loans sold by Resource to third party

purchasers prior to its acquisition by the Company. (2003 Form 10-K p.

85)

293. On May 4, 2005, defendant Herbert assured the investing public that the

Company had done so:

JOT IN HACKETT: That's sufficient for me. Thanks. With respect to the

loan loss provision, you referred to some of the provisions from the

dealer services that just as the portfolio matures. In the press release, it

looks like you referred to some height provision expenses in the

nonprime, nonconforming market. Can you give us a little more color on

that? Was there some credit going on in the mortgage side?

STEVE HERBERT: Yes. For the past three quarters what we are doing

there, we are really providing far what is called FIN 45 reserves. That's

life -- every time we sell a loan, there is a possibility that it will be put

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Case 1:07-cv-02298 -BBM Document 35-3 Filed 07/03/2008 Page 26 of 74

back due to standard reps and warranties, either for fraud or for basically

early payment default.

There are really two components to that long-teen calculation. One is

the frequency with which you will have to repurchase those loans, and

one is the severity. All our analysis continues to consolidate at a very

stable overall severity level. We feel very, very comfortable from the

over 6-7 year's worth of data that we know what on average we are

going to lose on those loans.

What we have seen in the last three quarters is an increase in the

frequency early in the life cycle ofcertain vintages ofproducts. That sort

of begs the question of will the fully seasoned frequency ofrepurchases

be higher because the early repurchase activity is higher than what we

have seen in the past or is the industry getting better at putting loans

back faster?

We do have some terminal points on the overall repurchase timelines,

but the bottom line is we have seen trends that have caused up to

increase, not the severity levels, but our expected cumulative frequency

expectations and we've made the necessary adjustments through

provision expense to put reserves out there for that. We are, and do

believe, that those numbers will stabilize in the future. We don't know

whether that has already happened or whether it will happen next quarter

or two quarters forward, because of the process we use we can't tell you

for sure when that will be. We can tell you that our process is responsive

to the data as it comes in and we are continuing to do some analysis

there to get at some of the root causes of what, where these repurchases

are coming from.

294. Later in that same conference call, Freeman reassured the investing

public of the reliability of NetBank's share price stating:

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We are experiencing some decent growth in the bank. We do pay a

dividend. We still have MNA obligations to build out our transaction

processing business and we still like the investment in our stock around

value, so all I can tell you is we try very hard to strike a balance between

all of those initiatives that we have underway.

295. On August 3, 2005, during a conference call with analysts, Defendant

Freeman again assured the investing public of the reliability ofNetBank's shareprice

stating:

We continue to manage capital in a very disciplined, proactive manner,

with an eye toward generating the greatest value for you, our

shareholder. During the second quarter, we repurchased

approximatelyl 50,000 shares at an average cost of S8.46 a share.

296. Defendants eventually acknowledged the following in the

MD&A of its 3Q2006 Form 10-Q tiled with the SEC November 9, 2006

regarding its representations and warranties liability, in relevant part:

Documentation. Repurchases related to documentation have increased

in recent years. During the last three years, NetBank produced and sold

a large volume of affordable housing program loans to FNMA. The

underwriting and. documentation requirements under such programs are

different than with traditional agency-eligible products in which the

Company regularly deals and have resulted in a greater number of

documentation deficiencies and consequently an increase in the volume

ofrepurchases.

^4 Y>kY

Early payment default. As is customary in whole loan sales, NetBank

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provides early payment default protection to the buyers. All offour sales

from our non-conforming channel are whole loan sales. The increased

production in this channel in recent years has given rise to an increase

in repurchase volumes for early payment default. Likewise,

commencing in 2004 and continuing in 2005 and 2006, our third party

conforming channel sold larger percentages of loans in whole loan sales

as opposed to agency mortgage backed securities, resulting in increases

in repurchase volume related to early payment default because whole

loan buyers are more likely to require sellers to repurchase loans in the

case of early payment default. (Q3 2006 Form I 0-Q p. 27) (Emphasis

added.)

297. Despite declining sales volumes the Company was incurring increasing

repurchase volumes. The increase in the Company's repurchase obligation had a

material impact on its results of operations, and consequently, its financial position.

The Company reported, although still insufficiently, related losses, in its Q3 2006

Form l0-Q, in relevant part:

...gain on sales of loans declined $23,118 during the three months

ended September 30, 2006 as compared to the same period in 2005

primarily due to continued competitive pressures within the secondary

market and higher repurchase volumes. (Q3 2006 Form l0-Q p. 29)

(Dollars in thousands.)

298. Finally, in the Company 's earnings release for the fourth quarter of2006

dated February 21, 2007, Defendants acknowledged, in relevant part:

As previously announced, repurchase requests in the non-conforming

mortgage channel rose sharply following management's decision to

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close the business and accelerated further at the end of the year.

Provisions for the non-conforming channel were $30.3 fnillion, an

increase of$25.7 million f-oni last quarter. Overall, provisions for the

financial intermediary segment were 532.0 million versus $12.2 million

the prior quarter. Management believes the worst ofthe non-conforming

loan repurchase problem is now behind the company given the

accelerated repurchase requests already received relative to the limited

non-conforming production over the second half of 2006.

299. As a result of Defendant' s failure to timely recognize known losses

regarding its representations and warranties liability, the Company's relevant

financial statements materially understated the Company's total liabilities and

materially overstated net income (or understated net losses, as applicable). Therefore,

the Company's relevant financial statements were materially false and misleading

regarding the Company's results of operations and financial position, and thus, were

not presented in conformity with GAAP.

C. Undisclosed Impairment of Goodwill

300. Additionally, as a result of the Defendant's failure to timely recognize

known losses regarding its representations and warranties liability, Defendants caused

the Company to issue the certain of the relevant financial statements which failed to

timely recognize impairment losses regarding the Company's non-conforming loan

operations and other non-traditional loan operations, specifically, regarding goodwill.

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301. Goodwill, generally, is the premium paid in an acquisition above the

acquired entity's identifiable fair value and, if any, is reported as an asset by the

acquiring entity. GAAP, specifically , FAS 142, Goodwill and Other Intangible Assets

("FAS 142"), requires goodwill to evaluated for impairment if an event occurs or

circumstances change that would more likely than not reduce the fair value of a

reporting unit (i.e. Heritage, the Company 's non-conform ing loan operations, or

Beacon, the Company's other non-traditional loan operations) below its carrying

amount, but, at a minimum, annually. (FAS 142 1128) (Emphasis added.) FAS 142,

further provides the guidance for recognizing and measuring goodwill impairment,

if any. FAS 142 requires a two-step process whereby an entity first determines if the

carrying value of a reporting unit exceeds the fair value of such reporting unit, and,

if so, then measures and recognizes the amount of impairment loss, if any, as the

amount that the carrying value of reporting unit goodwill exceeds the implied fair

value of such goodwill. (FAS 142 ¶28).

302. Had Defendants timely recognized known losses regarding its

representations and warranties liability, such losses would have been an indication

that, more likely than not, the fair value of the Company's non-conforming loan

operations had been reduced below its carrying value, thereby requiring an evaluation

-176-


of goodwill impairment resulting in the timely recognition of impairment losses.

Defendants disregarded its true losses regarding the Company's representations and

warranties liability, and thereby disregarded significant indication of the impairment

of goodwill related to its non-conforming loan operations, and avoided timely

recognizing the impairment losses.

303. Finally, as the indications of the impairment of goodwill related to its

non-conforming loan operations could not be further concealed, in the Company's

third quarter 2006 interim financial statements, the Defendants acknowledged, in

relevant part:

As a result of the Company's most recent impairment analyses,

performed during the third quarter of 2006, management recorded a

goodwill impairment of$19, 505 related to our nonconforming mnortgage

operations. The impairment charge eliminated all of the goodwill

related to our nonconforming operations and the Company received no

tax benefit from this charge. (Q3 2006 Form 10-Q p. 16) (Emphasis

added.)

304. As a result of Defendant ' s failure to timely recognize goodwill

impairment losses regarding its non-conforming loan operations, the Company's

relevant financial statements, exclusive of its third quarter 2006 interim financial

statements, materially overstated the Company's total assets and materially overstated

-177-


net income (or understated net losses, as applicable). Therefore, the Company's

relevant financial statements, exclusive of its third quarter 2006 interim Financial

statements, were materially false and misleading regarding the Company's results of

operations and financial position, and thus, were not presented in conformity with

GAAP.

305. Similarly, had Defendants timely recognized known losses regarding its

other non-traditional loan operations, such losses would have been an indication that,

more likely than not, the fair value of such reporting unit (i.e., Beacon) had been

reduced below its carrying value, thereby requiring an evaluation of goodwill

impairment, resulting in the timely recognition ofimpairment losses. As discussed in

greater detail elsewhere herein, the Company's expansion away from its core business

and into the other non-traditional loan market , paired with lax underwriting

guidelines, exposed the Company to a significant concentration of inherently high-

risk loans. Further, as discussed in greater detail elsewhere herein, Defendants were

aware, or should have been aware, that concentration, in combination with certain

prevailing market conditions, such as declining home values and increasing credit

delinquencies and defaults, impaired the reporting unit's financial position and

caused significant declines in the reporting unit's results of operations. Defendants

-178-


disregarded significant indications of the impairment of goodwill regarding its other

non-traditional loan operations and avoided timely recognizing the impairment losses.

306. As the indications ofthe impairment ofgoodwill regarding its other non-

traditional loan operations could not be further concealed, in the Company's Form 10-

Q for 2Q2006, filed with the SEC on August 8, 2006 , the Defendants admitted, in

relevant part as follows:

During the preparation and review of the these financial statements,

management determined, based. on currently available market

information as well as general trends in the industry, to record a

goodwill impairment of $6,358 with respect to the second quarter of

2006 related to our 2004 acquisition of Beacon Credit Services. The

impairment charge eliminated all ofthe goodwill related to the Beacon

acquisition. (Q2 2006 Form 10-Q p. 17) (Emphasis added.)

307. As a result of Defendant's failure to timely recognize goodwill

impairment losses regarding its other non-traditional loan operations goodwill, the

Company's relevant financial statements, exclusive of its second and third quarter

2006 interim financial statements, materially overstated the Company's total assets

and materially overstated net income (or understated net losses, as applicable).

Therefore, the Company's relevant financial statements, exclusive of its second and

third quarter 2006 interim financial statements, were materially false and misleading

regarding the Company's results of operations and financial position, and thus, were

-179-


not presented in conformity with GAAP.

308. NetBank's difficulties arising from Beacon were, in part, the result of

NetBank's failure to conduct due diligence prior to the acquisition. According to a

confidential witness, who was a senior executive ofNetBank during the entire Class

Period, and who had regular daily interaction with. defendants Freeman, Herbert and

Gross, it was defendant Freeman who made the decision for NetBank to purchase

Beacon , the financier of watercraft and aircraft . After the decision was made,

defendant Gross traveled to Connecticut to examine Beacon's books and records prior

to the sale. However, Gross was not permitted by Beacon to adequately examine those

books and records and a recommendation was made not to proceed with the purchase.

According to a confidential witness , who was a senior executive of NetBank during

the entire Class Period, and who had regular daily interaction with defendants

Freeman, Herbert and Gross, the principal of Beacon, at the time of the acquisition

by NetBank, was John Redmond who was a close personal friend of defendant

Freeman. Nevertheless, defendant Freeman disregarded the fact that Beacon would

not make its books and records available for inspection and the recommendation not

to purchase the company and pushed through the approval ofthe purchase ofBeacon

for $6.8 million. According to a July 2, 2004, press release issued by NetBank,

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Redmond, then a member of Beacon's senior management team , was poised to join

NetBank to oversee the Beacon division.

309. After acquiring it in .tune , 2004, Beacon caused NetBank to suffer a loss

of between approximately $200,000 and $300,000 every month, until the company

was essentially given back to Defendant Freeman's personal friend, Redmond, at no

cost in October 2006. The decisions o F the NetBank. Board of Directors were greatly

influenced by William (Mickey) Ross as they pertained to Beacon who operated

under the direction of Defendant Freeman. According to a confidential witness, who

was a senior executive of NetBank during the entire Class Period, and who had

regular daily interaction with defendants Freeman, Herbert and Gross, at least with

respect to the Beacon, Defendant Freeman effectively over-rode decisions of the

NetBank Board of Directors' and instead imposed conduct that he knew was not in

the best interest of NetBank or its investors. As alleged herein, also according to a

confidential witness who was a senior executive ofNetBank during the entire Class

Period and who had regular daily interaction with defendants Freeman, Herbert and

Gross, the Beacon transaction and related exotic lending programs were one of the

major contributing factors to NetBank's demise.

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A Overstatement of Mortgage-Servicing Rights Assets

310. Defendants caused the Company to issue the relevant financial

statements which failed to timely report known impairment losses regarding certain

of the Company's mortgage-related assets, specifically, mortgage-servicing rights

("MSRs").

311. MSRs, generally, are the expected future servicing revenues in excess

of expected future servicing expenses related to the servicing of a pool ofrnortgages.

GAAP, specifically, FAS 140, requires MSRs , subsequent to their initial recognition,

to be reported at the lower of cost or fair value. FAS 140 provides, in relevant part-

A servicer that recognizes a servicing asset... shall account for the

contract to service financial assets separately from those assets, as

follows:

f. Subsequently measure servicing assets by amortizing the

amount recognize-d in proportion to and over the period of

estimated net servicing income-the excess of servicing

revenues over servicing costs...

g. Subsequently evaluate and measure impairment of

servicing assets as follows:

(1) Stratify servicing assets based on one or more of thepredominant risk characteristics of the underlyingfinancial assets. Those characteristics may includefinancial asset type, size, interest rate, date of

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origination, term, and geographic location.

(2) Recognize impairment through a valuation

allowance for an individual stratum . The amount of

impairment recognized shall be the ainount hy which

the carrying amount of servicing assets Jrc)a

stratum exceeds their fair value. The fair value of

servicing assets that have not been recognized shall

not be used in the evaluation of impairment.

(3) Adjust the valuation allowance to reflect changes in

the measurement ofimpairment subsequent to the

initial measurement of impairment. Fair value in

excess ofthe carrying amount of'servicing assets for

that stratum, however, shall not he recognized. This

Statement does not address when an entity should

record a direct write-down of recognized servicing

assets... (FAS 140 1[63) (Emphasis added.) (Footnote

omitted.)

312. Changes in the fair value of MSRs are caused by changes in the

underlying pool ofmortgages. The Company indicated the following, in relevant part,

regarding the value of its MSRs:

An increase in delinquencies and defaults ofmortgage loans will also

adversely impact our loan servicing operations. Under certain types of

servicing contracts, particularly contracts to service pooled or

securitized loans, we must advance all or part ofthe scheduled payments

to the owner ofthe loan, even when loan payments are delinquent. Also,

to protect their lien on mortgaged property, owners of mortgage loans

usually require us to advance mortgage and hazard insurance and tax

-18^-

Case 1 : 07-cv-02298-BBM Document 35-3 Filed 07/03/2008 Page 38 of 74

payments on schedule even if sufficient escrow funds are unavailable.

A services is generally reimbursed for such advances by the mortgage

loan owner or from liquidation proceeds. However, prior to the

liquidation ofa loan, we Inust generally bear the cost offunds advanced

and the increased costs oJ' attempting to collect on delinquent and

defaulted mortgage loans. In addition, we must generally forego

servicing incomefrom the time such loan becomes delinquent until it is

,foreclosed upon or brought cur•r°ent. (2005 Form 10-K p. 38)

313. According to the Company's disclosures, its MSRs primarily related to

agency-eligible loans. Defendants described agency-eligible loans as follows:

Agency-eligible mortgage loans are those mortgage loans that meet the

size, documentation, borrower and credit standards to qualify to be

pooled into mortgage-backed securities guaranteed by government

sponsored enterprises, such as Fannie Mae, Freddie Mae and Ginnie

Mae. (2005 Form 10-K p. 13)

314. Thus, although agency-eligible loans would have typically excluded non-

conforming loans, based on the Company's definition and lack of any statements to

the contrary, it is reasonable to conclude such agency eligible loans included the

Company's other non-traditional loans, which was not the Company's core business,

and included those other non-traditional loans originated by the Company subject to

the Company's lax underwriting guidelines. Such factors, known to the Defendants,

and in combination with certain prevailing market conditions, such as declining home

-184-


values and increasing credit delinquencies and defaults, as discussed in greater detail

elsewhere herein, caused significant declines in the fair value of its MSRs.

Defendants disregarded the significant indications ofthe impairment ofits MSRs and

avoided timely recognizing the related known impairment losses.

315. Finally, as the Company was forced to sell-off a significant portion its

MSRs, the impairment of its MSRs could not be further concealed, Defendants

acknowledged, although still insufficiently, for the three months ended September 30,

2006, losses on sales ofM5Rs of$29.8 million, in addition to iVISR impairment losses

f r the three and nine months ended Septenmber 30, 2006 of, respectively, $ 1.5 million

and $7.4 million. (Q3 2006 Form I0-Q p. 4) Not until the second quarter of 2007 did

Defendants acknowledge, on the Company's Form 8-K filed with the SEC June 21,

2007, additional expected losses of $7.5 million on the sale of the Company's

remaining MSRs.

316. As a result of Defendant 's failure to timely recognize known losses

regarding the impairment of its MSRs, the Company's relevant financial statements

materially overstated the Company's total assets and materially overstated net income

(or understated net losses, as applicable). Therefore, the Company's relevant financial

statements were materially false and misleading regarding the Company's results of

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operations and financial position, and thus, were not presented in conformity with

GAAP.

E. Ineffective Disclosure Controls and Procedures and

Internal Control. over Financial Reporting

317. The SEC defines "disclosure controls and procedures" as:

...controls and other procedures of an issuer that are designed to ensure

that information required to he disclosed by the issuer in the reports

filed or submitted by it under the Exchange Act is recorded, processed,

summarized and reported, with the time periods specified in the

Commission 's rules and forms.... (SEC Final Rule Release Nos. 33-

8124, 34-46427, IC-25722; File No. S7 -21-02) (emphasis added and

footnotes omitted).

318. Internal control over financial reporting is defined in Public Company

Accounting Oversight Board ("PCAOB") Auditing Standard No. 2, An Audit of

Internal Control Over Financial Reporting.Perfbrmed in Conjunction with An Audit

ofFinancial Statements ("AS 2"), as follows, in relevant part:

A process designed by, or under the supervision of, the company's

principal executive and principal financial officers, or persons

performing similar functions, and effected by the company's board of

directors, management, and other personnel, to provide reasonable

assurance regarding the reliability of financial reporting and the

preparation qffinancial statementsfor externalpurposes in accordance

with, generally accepted accounting principles and includes those

policies and procedures that:

-186-


(1) Pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions anddispositions of the assets of the company;

(2) Provide reasonable assurance that transactions are recorded

as necessary to permit preparation of financial statements

in accordance with generally accepted accounting

principles, and that receipts and expenditures of the

company are being made only in accordance with

authorizations of management and directors of the

company; and

(3) Provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use ordisposition of the company's assets that could have amaterial effect on the financial statements.

Notably, the above definition is the same one used by the SEC in its rules requiring

management to report on internal control over financial reporting, except the word

"registrant " has been changed to "company" to conform to the wording in this

standard . (See Exchange Act Rules 13a-15(1) and 15d - 15(t).2/) (AS 2 ¶¶7).

319. Exchange Act Rules 13a- 14 and 15d-14 require the Company's principal

executive officer and principal financial officer, or equivalents, to quarterly and

annually certify the effectiveness (or disclose deficiencies in the effectiveness, as

applicable) of the Company's disclosure controls and procedures as of an assessment

-187-


date within 90 days prior to the filing date of the report. Further, the Company is

required to annually report on the effectiveness of its internal control over financial.

reporting. Auditing Standard No. 2 states, in relevant part:

A company subject to the reporting requirements of the SecuritiesExchange Act of 1934 (an "issuer") is required to include in its annualreport a report of management on the company's internal control overfinancial reporting... The report of management is required to containmanagement's assessment ofthe effectiveness ofthe company's internalcontrol over financial reporting as of the end of the company's mostrecent fiscal year, including a statement as to whether the company'sinternal control over financial reporting is effective... (AS 2 ¶2).

320. During the Class Period, Defendants caused the Company to issue

materially false and misleading statements regarding the effectiveness of the

Company's disclosure controls and procedures, and internal control over financial

reporting. With the exception of December 31, 2004, Defendants disclosed the

Company's disclosure controls and procedures were effective as of the date of each

individual Exchange Act report that was filed during the Class Period. (Q1 2005

Form 10-Q p. 28, Q2 2005 Form 10-Q p. 3 6, Q3 2005 Form 10-Q p. 37, 2005 Form

1.0-K p. 124, Q 1 2006 Form 10-Q p. 34, Q2 2006 Form 10-Q p. 41, Q3 2006 Form

10-Q p. 39) Further, Defendants disclosed that internal control over financial

reporting as of December 31, 2005. (2005 Form 10-K p. 125).

-188-


32 1. Defendants caused the Company to issue the relevant financial

statements that were materially misstated with respect to the Company's

representations and warranties liability, goodwill, and MSRs and avoided timely

recognizing losses. Defendants caused the Company to issue the relevant financial

statements which were materially false and misleading regarding the Company's

results of operations and financial position, and thus, were not presented in

conformity with GAAP. Thereby, the Company's disclosure controls and procedures,

and internal control over financial reporting, were not effective as of the date of each

individual Exchange Act report that was filed during the Class Period.

XlI. ADDITIONAL SCIENTER ALLEGATIONS

322. As alleged herein, Defendants acted with scienter in that Defendants

knew 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, approved or acquiesced in the issuance or

dissemination of such statements or documents as primary violations 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 NetBank, their control over,

-189-


receipt of and/or modification of NetBank's allegedly materially misleading

misstatements and/or their associations with the Company which made them privy to

confidential proprietary information concerning NetBank, participated in the

fraudulent scheme alleged herein..

323. Among other things, Defendants' scienter is specifically demonstrated

by their intentional and purposeful withholding of information from the investing

public as to the SEC's communications and investigations into the Company's

material misapplication of GAAP and FAS 133 in connection with its financial

reporting with the SEC. Such misapplications materially misstated the Company's

financial statements as to the results and condition of the Company since at least

March 16, 2005. Defendants admit they were notified by the SEC of such accounting

misstatements as early as August 31, 2006, but purposely withheld that information

from the investing public for nearly a year, and finally disclosed such information on

August 10, 2007, when NetBank was in its final throes of its ultimate collapse.

Defendants' withholding of this information was designed to conceal and continue

their fraudulent scheme as alleged.

324. Similarly, Defendants failed to disclose that the resignation ofNetBank's

independent auditor was directly related to the Company's GAAP violations and

-190-


internal control failings, including its misapplication of FAS 133. Indeed , nearly a

year after E&Y resigned, the Company revealed that E&Y had actually withdrawn its

prior audit opinions for NetBank's 2004 and 2005 Form 10-K. E&Y was also then

refusing to allow for NetBank to File its 2006 FormI0-K as a further result.

325. Defendants' scienter is further demonstrated by their intentional and

purposeful failure to file any financial reports with the SEC following the filing ofthe

Form l0--Q for the fiscal quarter ended September 31, 2006..As such, Defendants not

only failed to report timely and accurately NetBank's financial results and condition

after 3Q2006, but Defendants failed to correct and restate the Company prior

financial statements, and instead simply waited for the Company to declare

bankruptcy and dissolve. Defendants' actions and inactions in this regard amounted

to a concerted effort to conceal their fraud as alleged herein.

XIII. LOSS CAUSATION/ECONOMIC LOSS

326. During the Class Period, as alleged. herein, the Defendants engaged in

a scheme to deceive the market and artificially inflate the price of NetBank's

securities . In doing so, Defendants made material misrepresentations and omissions

regarding, among other things, the Company's financial reporting, financial

-191-


condition, internal controls, business operations, corporate restructuring, core

banking business, lending practices and exposure to subprime mortgages. When the

truth concerning these issues was revealed to the investing public beginning on May

21, 2007, the price of NetBank ' s securities materially declined as the remaining

artificial inflation dissipated. As a result of their purchases of NetBank securities

during the Class Period at artificially inflated prices and subsequent disclosures

which removed the inflation from such securities, Plaintiff and other members ofthe

Class suffered economic loss, i.e., damages under the federal securities laws.

327. The markets for NetBank' s securities were open, well-developed and

efficient at all relevant times. As a result of these materially false and misleading

statements and failures to disclose, NetBank's securities traded at artificially inflated

prices during the Class Period. Plaintiff and other members of the Class purchased or

otherwise acquired NetBank securities relying upon the integrity of the market price

of NetBank's securities and market information relating to NetBank, and have been

damaged thereby.

328. During the Class Period, Defendants materially misled the investing

public, thereby inflating the prices of NetBank's securities , by publicly issuing false

and misleading statements and omitting to disclose material facts necessary to make

-192-


Defendants' statements, as set forth herein, not false and misleading. Said statements

and omissions were materially false and misleading in that they fail to disclose

material adverse information and misrepresented the truth about the Company, its

business and operations, as alleged herein.

329. At all relevant times, the material misrepresentations and omissions

particularized in this Amended Complaint directly or proximately caused, or were a

substantial contributing cause of, the damages sustained by Plaintiff and other

members ofthe Class. As described herein, during the Class Period, Defendants made

or caused to be made a series of materially false or misleading statements about

NetBank's business, prospects, operations and results. These material misstatements

and omissions had the cause and effect of creating in the market an unrealistically

positive assessment of NetBank and its business , prospects, operations and results,

thus causing the Company's securities to be overvalued and artificially inflated at all

relevant times.

330. When the full impact of Defendants' prior misrepresentations and

fraudulent conduct were disclosed and became apparent to the market, the prices of

NetBank' s securities fell precipitously as the remaining artificial inflation came out.

As a result of their purchases of NetBank' s securities during the Class Period,

-193-


Plaintiff and the other Class members suffered economic loss, i.e., damages under the

federal securities laws,

331. By failing to disclose the truth about its core businesses, lending policies

and practices and accounting practices, Defendants presented a misleading picture of

NetBank's operations and financial performance. Thus, instead of disclosing during

the Class Period the truth about NetBank's business, prospects, operations and

results, Defendants caused NetBank to conceal the truth.

332. Defendants' false and misleading statements had the intended effect and

caused NetBank's common stock to trade at artificially inflated levels throughout the

Class Period, reaching as high as $8.74 per share on May 16, 2005, the start of the

Class Period.

333. Beginning at least as early as October 2006, adverse facts and

circumstances attributable to the fraud alleged herein were learned by the investing

public, and as a result, the price of NetBank stock suffered numerous declines. This

adverse information included the "resignation", or firing of NetBank CEO Freeman,

the resignation of NetBank's auditor E&Y, reports of dismal financial results,

reported delays in reporting financial data and filing requisite reports with the SEC,

-194-


and the Company's failure to file requisite financial reports with the SEC. "While

these adverse disclosures revealed business reversals caused by defendants' fraud,

and precipitated stock price declines which were the consequence of Defendants'

fraud (and its gradual unraveling), the major elements ofthe fraudulent scheme itself

were not revealed until the Company's shocking disclosures on May 21, 2007, and

thereafter.

334. As a direct result of Defendant s' disclosures on May 21, 2007,

NetBank's common stock price fell precipitously. These drops removed the remaining

inflation from the price of NetBank's securities, causing real economic loss to

investors who had purchased the Company's securities during the Class Period.

335. The approximate 92% decline in the price ofNetBank's common stock

after these disclosures came to light was a direct result of the nature and extent of

Defendants ' fraud finally being revealed to investors and the market. The timing and

magnitude of NetBank's common stock price declines negate any inference that the

loss suffered by Plaintiffand the other Class members was caused by changed market

conditions, macroeconomic or industry factors or Company-specific facts unrelated

to the Defendants' fraudulent conduct. The economic loss, i.e., damages, suffered by

Plaintiff and the other Class members was a direct result of Defendants' fraudulent

-195-


scheme to artificially inflate the prices of NetBank's securities and the subsequent

significant decline in the value of NetBank's securities when Defendants' prior

misrepresentations and other fraudulent conduct were revealed.

336. The price declines directly and proximately resulting from the above

discussed disclosures were not caused by industry news, randomness or by NetBank

related information unrelated to the alleged fraud. Each of the above referenced

disclosures partially corrected the false and misleading information previously

available to the market by the Defendants' wrongful course of conduct. Plaintiff and

the Class seek by this Amended Complaint to be compensated for those resulting

economic losses.

XIV. FRAUD ON THE MARKET DOCTRINE

3 37. Throughout the Class Period the market for NetBank common stock was

an efficient market for the following reasons, among others:

a. NetBank common stock met the requirements ror listing, and was

listed and actively traded on the NASDAQ;

b. As a regulated issuer of securities, NetBank filed periodic public

reports with the SEC and the NASDAQ;

-196-


c. The common stock of NetBank was followed by securities

analysts who wrote research reports that were distributed to brokerage sales personnel

and to customers of investment firms. These research reports were publicly available

and entered the public marketplace; and

d. Plaintiff and the other members of the proposed Class purchased

NetBank common stock and other securities during the time Defendants are alleged

to have engaged in the fraudulent acts and practices alleged herein, and did not know

the truth.

338. The -market for NetBank common stock promptly digested current

information with respect to NetBank common stock from all publicly available

sources, and all such information was reflected in the market prices of said securities.

Under these circumstances, all those who purchased NetBank common stock during

the Class Period suffered similar injury through their acquisition of such securities

at artificially inflated prices. Hence, the fraud-on-the-market doctrine of reliance

applies to the claims alleged herein.

339. At all relevant times, the market for NetBank's securities was an efficient

market for the following reasons, among others:

-197-


(a) NetBank's stock met the requirements for listing, and was listed and

actively traded on the National Association of Securities Dealers Automated

Quotation System ("NASDAQ"), a highly efficient and automated market;

(b) as a regulated issuer, NetBank filed periodic public reports with the SEC

and the NASDAQ;

(c) NetBank regularly communicated with public investors via established

market communication mechanisms, including through conference calls with

investors and the issuance ofpress releases on the national circuits ofmajor newswire

services and through other wide-ranging public disclosures, such as communications

with the financial press and other similar reporting services; and

(d) NetBank was.followed by several securities analysts employed by major

brokerage firms who wrote reports which were distributed to the sales force and

certain customers of their respective brokerage firms. Each of these reports was

publicly available and entered the public marketplace.

340. As a result of the foregoing, the markets for NetBank's securities

promptly digested current information regarding NetBank from all publicly available

sources and reflected such information in the price of the Company's securities.

-198-


Under these circumstances , all purchasers of NetBank 's securities during the Class

Period suffered similar injury through their purchase of the publicly traded securities

of NetBank at artificially inflated prices, and a presumption of reliance applies.

XV. INAPPLICABILITY OF SAFE HARBOR

341. The statutory safe harbor provided for forward-looking statements

("FLS") does not apply to any false FLS that may be pleaded herein. The statutory

safe harbor for FLS does not apply because the safe harbor exempts from coverage

the Company's false financial statements. Moreover, any such FLS pleaded herein

were not specifically identified. as "forward-looking statements" when made and/or

were not accompanied by meaningful cautionary statements identifying important

factors that could cause actual results to differ materially from those in the FLS. To

the extent that the statutory safe harbor may apply to any of these false statements

alleged herein, the Defendants are liable for those false forward-looking statements

because at the time each of those statements was made the speaker actually knew the

statement was false and the statement was authorized and/or approved by an

executive officer of NetBank who actually knew that those statements were false

when made.

-199-


CLAIMS FOR RELIEF

COUNT I

Violation of Section 10(b) of the Exchang e Act and Rule lOb-5

Promulgated Thereunder Against All Defendants

342. Plaintiffrepeats and realleges each and every allegation contained above

as if fully set forth herein.

343. During the Class Period, Defendants carried out a plan, scheme and

course of conduct which was intended to and, throughout the Class Period, did: (i)

deceive the investing public regarding NetBank's business, operations, management

and the intrinsic value of NetBank securities; and (ii) cause Plaintiff and other

members of the Class to purchase NetBank's securities at artificially inflated prices.

In furtherance of this unlawful scheme, plan and course of conduct, Defendants, and

each of them, took the actions set forth herein.

344. Defendants: (a) employed devices, schemes, and artifices to defraud; (b)

made untrue statements of material fact and/or omitted to state material facts

necessary to make the statements not misleading; and (c) engaged in acts, practices,

and a course of business which operated as a fraud and deceit upon the purchasers of

-200-


the Company's securities in an effort to maintain artificially high market prices for

NetBank's securities in violation of Section 10(h) of the Exchange Act and Rule I Ob-

5 promulgated thereunder. All Defendants are sued either as primary participants in

the wrongful and illegal conduct charged herein or as controlling persons as alleged

below.

345. Defendants, individually and in concert, directly and indirectly, by the

use, means or instrumentalities of interstate commerce and/or of the mails, engaged

and participated in a continuous course of conduct to conceal adverse material

information about the business, operations and future prospects of NetBank as

specified herein.

346, These Defendants employed devices, schemes and artifices to defraud,

while in possession of material adverse non-public i.nf'ormation and engaged in acts,

practices, and a course of conduct as alleged herein in an effort to assure investors of

NetBank's value and performance and continued substantial growth, which included

the making of, or the participation in the making of, untrue statements of material

facts and omitting to state material facts necessary in order to make the statements

made about NetBank and its business operations and future prospects in the light of

the circumstances under which they were made, not misleading, as set forth more

-201-


particularly herein, and engaged in transactions, practices and a course of business

which operated as a fraud and deceit upon the purchasers of NetBank's securities


347. Each of the Individual Defendants' piiimary liability, and controlling

person liability, arises from the following facts: (i) the Individual Defendants were

high-level executives and/or directors at the Company during the Class Period and

members of the Company's management team or had control thereof, (ii) each of

these Defendants , by virtue of his responsibilities and activities as a senior officer

and/or director of the Company was privy to and participated in the creation,

development and reporting of the Company's internal budgets, plans, projections

and/or reports; (iii) each ofthese Defendants enjoyed significant personal contact and

familiarity with the other Defendants and was advised of and had access to other

members of the Company's management team, internal reports and other data and

information about the Company's finances, operations, and sales at all relevant times

; and (iv) each of these Defendants was aware of the Company"s dissemination of

information to the investing public which they knew or recklessly disregarded was

materially false and misleading.

348. The Defendants had actual knowledge of the misrepresentations and

-202-


omissions of material facts set forth herein, or acted with reckless disregard for the

truth, in that they failed to ascertain and to disclose such facts, even though such facts

were available to them. Such Defendants ' material misrepresentations and/or

omissions were done knowingly or recklessly and for the purpose and effect of

concealing NetBank's operating condition and future business prospects from the

investing public and supporting the artificially inflated price of its securities . As

demonstrated by Defendants ' overstatements and misstatements of the Company's

business, operations and earnings throughout the Class Period, Defendants, ifthey did

not have actual knowledge of the misrepresentations and omissions alleged, were

sufficiently reckless in failing to obtain such knowledge by deliberately refraining

from taking those steps necessary to discover whether those statements were false or

misleading.

349. As a result of the dissemination of the materially false and misleading

information and failure to disclose material facts, as set forth above, the market prices

ofNetBank' s securities were artificially inflated during the Class Period. In ignorance

ofthe fact that market prices ofNetBank's pu blicly-traded securities were artificially

inflated, and relying directly or indirectly on the false and misleading statements

made by Defendants, or upon the integrity ofthe market in which the securities trade,

-203-


and/or on the absence of material adverse information that was known to or recklessly

disregarded by Defendants but not disclosed in public statements by Defendants

during the Class Period, Plaintiff and the other members of the Class acquired

NetBank securities during the Class Period at artificially high prices and were

damaged thereby.

350. At the time of said misrepresentations and omissions, Plaintiff and other

members ofthe Class were ignorant of their falsity, and believed them to be true. Had

Plaintiff and the other members of the Class and the marketplace known the truth

regarding NetBank's Financial results, which were not disclosed by Defendants,

Plaintiff and other members of the Class would not have purchased or otherwise

acquired their NetBank securities, or, if they had acquired such securities during the

Class Period, they would not have done so at the artificially inflated prices which they

paid.

351. By virtue of the foregoing, Defendants have violated Section 10(b) of

the Exchange Act, and Rule I Ob-5 promulgated thereunder.

352. As a direct and proximate result of Defendants ' wrongful conduct,

Plaintiff and the other members of the Class suffered damages in connection with

-204-


their respective purchases and sales of the Company's securities during the Class

Period.

COUNT 1[

Violation of Section 20(a) Of

The Exchange.A.et Against the Individual Defendants

353. Plaintiff repeats and realleges each and every allegation contained above

as if fully set forth herein.

354. The Individual Defendants acted as controlling persons of NetBank

within the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue

of their high-level positions, and their ownership and contractual rights, participation

in and./or awareness of the Company's operations and/or intimate knowledge of the

false financial statements filed by the Company with the SFC and disseminated to the

investing public, the Individual Defendants had the power to influence and control

and did influence and control, directly or indirectly, the decision-making of the

Company, including the content and dissemination of the various statements which

Plaintiff contends are false and misleading. The Individual Defendants were provided

with or had. unlimited access to copies of the Company's reports, press releases,

-205-


public filings and other statements alleged by Plaintiff to be misleading prior to

and/or shortly after these statements were issued and had the ability to prevent the

issuance of the statements or cause the statements to be corrected.

355. In particular, each of these Defendants had direct and supervisory

involvement in the day-to-day operations ofthe Company and, therefore, is presumed

to have had the power to control or influence the particular transactions giving rise

to the securities violations as alleged herein, and exercised the same.

356. As set forth above, NetBank and the Individual Defendants each violated

Section 10(b) and Rule lOb-5 by their acts and omissions as alleged in this

Complaint. By virtue of their positions as controlling persons, the Individual

Defendants are liable pursuant to Section 20(a) of the Exchange Act. As a direct and

proximate result ofDefendants' wrongful conduct, Plaintiff and other members ofthe

Class suffered damages in connection with their purchases of the Company's

securities during the Class Period.

PRAYER FOR RELIEF

WHEREFORE , Plaintiff, on his own behalf and on behalf of the other

members of the Class, demands judgment against the Defendants as follows:

-206-


A. Determining that this action is properly maintainable as a class action

pursuant to Rule 23 of the Federal Rules of Civil Procedure;

B. Certifying Plaintiff as the representative of the Class and his counsel as

counsel for the Class;

C. Declaring that Defendants violated the federal securities laws by reason

of the wrongful conduct alleged herein;

D. Awarding monetary damages against all Defendants, jointly and

severally, in favor of Plaintiff and the other members of the Class for all losses and

damages suffered as a result of the acts and transactions complained of herein,

together with prejudgment interest from the date of the wrongs to the date of the

judgment herein;

E. Awarding Plaintiff the costs, expenses, and disbursements incurred in

this action, including reasonable attorneys' and experts' fees; and

F. Awarding Plaintiff and the other members of the Class such other and

further relief as the Court may deem just and proper in light of all the circumstances

of this case.

-207-


JURY TRIAL DEMAND

Plaintiff demands a trial byjury of all claims and issues so triable in this action.

Dated: July 3 , 2008

/s/ Michael J. Gorby! _

Michael J. Gorby, Esq.

Mary Donne Peters, Esq.

GORBV, PETERS &

ASSOCIATES, P.C.

Two Ravinia Drive, Suite 150()

Atlanta, GA 30346-2104

Telephone: (404) 239-1150

Fax: (404) 239-.1179

mgorby@gorbyree-\,-,es.com

mpeters[c gorbyreeves.com

Respectfully submitted,

/s/ Merrill G. Davidoff

Merrill G. Davidoff, Esq.

Michael Dell'Angelo, Esq.

Lane L. Vines, Esq.

BERGER & MONTAGUE, P.C.

1622 Locust Street

Philadelphia, PA 19103

Telephone: (215) 875-3000

Fax: (215) 875-4604

mdavido ffir^,bn1. net

[email protected]

[email protected]

Local Counsel for Lead Plaintiff

Robert A. Brown and the Proposed

Class

Lead Counsel for Lead Plaintiff

Robert A. Brown and the Proposed

Class

-208-


ATTACHMENT


IN THE UNITED STATES DISTRICT COURTFOR THE NORTHERN DISTRICT OF GEORGIA

ATLANTA DIVISION

JOHNNY R. ADCOCK,on Behalf of Himself and All OthersSimilarly Situated,

Plaintiff,

V.

NETBANK, INC., STEVEN F. HERBERTand DOUGLAS K. FREEMAN,

Defendants.x

ARASH VAHDAT,on Behalf of Himself and All OthersSimilarly Situated,

Plaintiff,

V.

NETBANK, INC., STEVEN F. HERBERTand DOUGLAS K. FREEMAN,

Defendants.

C.A. No. 1:07-CV-2298-BBM

JURY TRIAL DEMANDED

C.A. No. l:07-CV-2631-BBM

JURY TRIAL DEMANDED

CERTIFICATION OF ROBERT A. BROWN PURSUANT TO THEPRIVATE SECURITIES REFORM ACT OF 1995 "PSLRA"

Robert A. Brown ("Plaintiff'), duly swears and says , as to the claims

asserted under the federal securities laws, that:

1. 1 have reviewed the complaints filed in the litigations captioned


Adcock v. NetBank, Inc., et al., No. 07-cv-02298-BBM (N.D. Ga.) and Vahdat v.

NetBank, Inc., et al., No. 07-cv-02631-BBM (N.D. Ga.), which alleged violations

of the federal securities laws against NetBank, Inc. ("NetBank" or the "Company")

and several of its officers and directors , including Steven F. Herbert and Douglas

K. Freeman. I have also reviewed a draft complaint that may be filed on my behalf

against NetBank, Inc. and related persons. I approve of its contents, and I

authorize its filing. I authorize Berger & Montague, P.C. to represent me in this

action.

2. 1 did not purchase the security that is the subject of this action at the

direction of my counsel or in order to participate in this private action.

3. I am willing to serve as a representative plaintiff on behalf of the

class, including providing testimony at deposition and trial, if necessary.

4. My transactions in the common stock ofNetBank the relevant class

period March 16, 2005 through and including May 21, 2007 are as follows:

SHARES DATE OFPURCHASED PURCHASE

See attached schedule

SHARES DATE OFSOLD SALE

See attached schedule

PRICE PER

SHARE

PRICE PER

SHARE

2


5. 1 state that I own and/or control, on behalf of myself and members of

my immediate family, the several investment accounts, listed on the attached

schedule: Robert A. Brown IRA; Robert A. Brown & Judith E. Thomson

JTWROS; Robert A. Brown, Custodian FBO Jared T. Brown; Robert A. Brown,

Custodian FBO Maia T. Brown; and Judith E. Thomson IRA. Ms. Judith Thomson

is my wife. Jared T. Brown and Maia T. Brown are my minor children. At all

times relevant, I had and exercised complete investment control and authority for

all investment transactions in all of the above accounts.

6. In the three years (3) prior to the date of this certification, I have

served as the court-appointed lead plaintiff and class representative in one other

action filed under the United States federal securities laws; that litigation is

captioned Brown v. Kinross Gold U.S.A., Inc., No. CV-S-02-0605-KJD-(RJJ) (D.

Nev.). Specifically, I was appointed by the court in that litigation to serve as one

of the several lead plaintiffs by Order entered August 8, 2002 and as one of the

several class representatives by Order entered June 14, 2005. Other than the above

Kinross litigation, I have not previously sought to serve as a representative party in

an action filed under the United States federal securities laws.

7. 1 have not and will not accept any payment for serving as a


Type of transaction

Robert A. Brown IRA

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Totals

sellSell

Sell

Totals

Net Loss

Robert A . Brown & Judith E. Thomson

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

Buy

ROBERT A. BROWNNETBANK, INC. COMMON STOCKTRANSACTIONAL SUMMARY

Date Shares traded Price uer ShareTotal dollar value of

frarsaction

09-May-2006 45.7778 $6.750 -$309.00

18-May-2006 51.3333 $6.000 -$309.00

23-May-2006 49.6774 $6,200 -$309.00

06-Jun-2006 50.5728 $6.110 -$309.00

13-Jun-2006 49.6774 $6.200 -$309.00

15-Jun-2006 0.3207 $6.049 -$1.94

20-Jun-2006 50.1751 $6.139 -$309.00

02-Feb-2007 114,450.0000 $3.715 -$425,178.70

05-Feb-2007 157,000.0000 $3.705 -$581,681.95

07-Feb-2007 141,318.0000 $3.665 -$517,927.42

28-Feb-2007 458,0000 $3,200 -$1,473.60

06-Mar-2007 998.1618 $2.724 -$2,719.00

13-Mar-2007 100.0000 $2.490 -$257.00

14-Mar-2007 163,446.0000 $2.490 -$406,988.54

27-Mar-2007 98,522.0000 $2.395 -$235,961.14

676,589.6963 -2,174,043.2900

24-May-2007 512,585.6963 $0.390 $195,075.18

24-May-2007 12,800.0000 $0.390 $4,931.71

24-May-2007 151,204.0000 $0,390 $58,208.88

676,589.6963 $ 258,215.77

11-Oct-2005 26.7606 $7.810 -$209.00

18-Oct-2005 27.1429 $7.700 -$209.00

25-Oct-2005 26.4968 $7.888 -$209.00

01-Nov-2005 26.4892 $7.890 -$209.00

08-Nov-2005 27.4151 $7.660 -$210.00

15-Nov-2005 14.0677 37.110 -$100.00

15-Nov-2005 29.4014 $7.110 -$210.00

22-Nov-2005 28.6694 $7.290 -$210.00

06-Dec-2005 28.9041 $7.300 -$211.00

13-Dec-2005 42.3024 $7.210 -$306,00

15-Dec-2005 0,3087 57.839 -$2.42

15-Dec-2005 0.1454 $7.840 -$1.14

20-17ec-2005 42,0110 $7.260 -$306.00

27-Dec-2005 41.5531 $7.340 -$306.00

03-Jan-2006 42.7374 $7.160 -$306.00

10-Jan-2006 40.7210 $7.490 $306.00

17-Jan-2006 41.1611 $7,410 -$306.00

24-Jan-2006 42.3024 $7.210 $306.00

Total Losses

$ -1,915,827.52


Type of transaction Date Shares traded Price per ShareTota l dollar value of

Total Lossestransaction

Buy 07-Feb-2006 41.0428 $7.480 -$307.00Buy 14-Feb-2006 41.0738 $7.450 -$307.00

Buy 21-Feb-2006 41,3737 $7.396 -$307.00Buy 26-Feb-2006 41.9399 $7.320 -$308.00Buy 07-Mar-2006 42.5414 $7.240 -$308.00Buy 14-Mar-2006 41.9973 $7.310 -$308.00Buy 15-Mar-2006 1.6703 $7.310 -$12.21Buy 21-Mar-2006 40.7324 $7.537 -$308.00

Buy 28-Mar-2006 42.7577 $7.180 -$308.00

Buy 04-Apr-2006 42.7778 $7.200 -$308.00Buy 11-Apr-2006 42.8173 $7.170 -$308.00Buy 18-Apr-2006 42,2289 $7170 -$308.00Buy 25-Apr-2006 44.3642 $6.920 -$308.00

Buy 02-May-2006 44.6377 $6.900 -$308.00Buy 15-Jun-2006 3.5719 $6.050 -$21.61

Buy 21-Feb-2007 500.0000 $3.520 $1,765.95Buy 22-Feb-2047 2,108.0000 $3.600 47,410.57

Buy 27-Feb-2007 2,644.0000 $3.460 -$9,188.85Buy 28-Feb-2007 2,817.0000 $3.250 -$9,198.46Buy 13-Mar-2007 3,764.1801 $2.656 -$10,000.00Buy 13-Mar-2007 100.0000 $2.490 -$257.00Buy 14-Mar-2007 1,800.0000 $2,480 -$4,464.00

Buy 14-Mar-2007 5,944.0000 $2,485 -$14,778.84

Buy 14-Mar-2007 25,500.0000 $2,490 -$63,495.00Buy 20-Mar-2007 4,462.5000 $2,240 410,000.04Buy 22-Mar-2007 18,173.0000 $2.170 -$39,708.96

Buy 22-Mar-2007 418.0000 $2.350 -$996.25

Buy 23-Mar-2007 7,398.0000 $2.340 417,423.24

Buy 23-Mar-2007 3,400.0000 $2.410 -$8,245.95Buy 26-Mar-2007 21,617.0000 $2.390 -$51,660.58Buy 27-Mar-2007 28,612.0000 $2,390 -$68,812.81

Buy 24-Apr-2007 3,249.2537 $2.010 46,535.00

Totals 133591.0506 $331,920.84

Sell 22-May-2007 100,247.0506 $0.373 $36,469.96

Sell 24-May-2007 33,344.0000 $0.390 $12,834.01

Totals 133,591.0506 $49,303.97

Not Loss $ -295,450.88

Robert A. Brown. Custodian FBO Jared T. Brown

Buy 06-Mar-2007 156.2500 $2.720 $429.00

Buy 27-Mat-2007 2,289.5833 $2.400 -$5,499.00

Totals 2,445.8333 -$5,928.00

Sell 22-May-2007 2,445.8333 $0.566 $1,384.34

Net Loss $ -4.543.66


Type of transaction ate Shares traded Price per ShareTotal dollar value of

transaction

Robert A . Brown, Custodian FBO Maia 7 Brown

Buy 10-Apr-2007 3,013.4805 $1,780 -$5,367.00

Sell 22-May-2007 3,013.4805 $0.568 $1,705.63

Net Loss

Judith E. Thomson IRA

Buy 27-Jun-2006 57.1205 $6.390 -$365.00

Buy 05-Jul-2006 58.2137 $6.271) -$365.00

Buy 11-Jul-2006 55.9140 $6.510 -$365.00

Buy 18-Jul-2006 58.6161 $8.210 -$365.00

Buy 25-Jul-2006 57.8862 36.310 -$365.00

Buy 01-Aug-2006 69.3916 35.260 -$365.00

Buy 08-Aug-2006 86.6667 $4.200 -$365.00

Buy 15-Aug-2006 66.2059 35.498 -$365.00

Buy 22-Aug-2006 67.6580 $5.380 -$365.00

Buy 05-Sep-2006 62.3942 35.850 -$365.00Buy 12-Sep-2006 59.8684 $6.080 -$365.00

Buy 19-Sep-2006 61.3828 35.930 -$365.00

Buy 26-Sep-2006 60.06660 36.060 -$365.00

Buy 03-Oct-2006 60,6312 $6.020 -$365.00

Buy 10-Oct-2006 58.2400 36.250 -$365.00

Buy 17-Oct-2006 60.6667 $6.000 -$365.00

Buy 24-Oct-2006 63.2054 $5.759 -$365.00Buy 07-Nov-2006 66.7276 $5.470 -$365.00

Buy 14-Nov-2006 68.6792 $5.300 -$365.00

Buy 21-Nov-2006 69.5985 $5230 -$365.00

Buy 28-Nov-2006 75.5579 $4.818 -$365.00

Buy 05-Dec-2006 78.3262 $4.660 -$365.00

Buy 12-Dec-2006 77.4468 $4.700 4365.00

Buy 19-Deo-2006 86.5225 $4.207 -$365.00Buy 26-11^-2006 79.6499 $4.570 -$365.00

Buy 03-Jan-2007 842956 $4.330 -$385.00

Buy 09-Jan-2007 89.8765 $4.050 -$365.00

Buy 16-Jan-2007 88.9976 $4.090 -$365.00

Buy 23-Jan-2007 94.5595 $3.860 -$366.00

Buy 06-Feb-2007 97.6000 $3.750 -$366.00Buy 08-Feb-2007 14,200.0000 $3.580 -$51,045.95

Buy 14-Feb-2007 73,472.0000 $3.580 -$264,128.79Buy 28-Feb-2007 520.0000 $3.200 -$1,672.00

Buy 06-Mar-2007 429.0441 $2,720 -$1,171.00

Buy 14-Mar-2007 72,685.0000 $2.480 -$180,266.80

Buy 16-Mar-2007 11,692.0000 $2.480 -$29,004.16Buy 27-Mar-2007 6,033.0000 $2.380 -$14,449.99Buy 28-Mar-2007 78,651.0000 $2.380 -$188,370.10

Totals 259,8Q3.8094 -$741,060.79

Total Losses

$ -3,661.37


Type of transaction Date Shares traded Price per Share

Sell 24-May-2007 174,9M.8094 $0.390Sell 24-May-2007 84,897.0000 $0.390

Totals 259,803.8094

Net Loss

TOTAL SHARES 1,075,443.8701

TOTAL NET LOSS

Total dollar value oftransaction

$66,507.28

$32,680.90

$99,188.18

Total Losses

$ -674,553.51

$ -2,894,036.94


IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF GEORGIAATLANTA DIVISION

Civil Action No . 1:07-cv-2298

IN RE NETBANK, INC.SECURITIES LITIGATION Jury Trial Demanded

CERTIFICATION

Submitting Counsel hereby certifies that the text of the foregoing document

has been prepared with Times New Roman 14 point, one of the fonts and point

selections approved by the Court, and complies in all respects with Local Rule

5.1(C) of the United States District Court, Northern District of Georgia.

Dated : July 3 , 2008

Isf Michael J. GorbyMichael J. Gorby, Esq.Mary Donne Peters, Esq.GORBY, PETERS &ASSOCIATES, P.C.

Two Ravinia Drive, Suite 1500Atlanta, GA 30346-2104Telephone: (404) 239-1150Fax: (404) [email protected]@gorbyreeves.com

Is/ Merrill G. DavidoffMerrill G. Davidoff, Esq.Michael Dell'Angelo, Esq.Lane L. Vines, Esq.

BERGER & MONTAGUE, P.C.1622 Locust StreetPhiladelphia, PA 19103Telephone: (215) 875-3000Fax: (215) [email protected]@[email protected]

Local Counselfor Lead PlaintiffRobert A. Brown and the ProposedClass

Lead Counselfop Lead PlaintiffRobert A. Brown and the Proposed

Class


IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF GEORGIAATLANTA DIVISION

Civil Action No. 1:07-cv-2298IN RE NETBANK, INC.SECURITIES LITIGATION

Jury Trial Demanded

CERTIFICATE OF SERVICE

This is to certify that I have this day served counsel for all parties in the

foregoing matter with a copy of CONSOLIDATED AND AMENDED CLASS

ACTION COMPLAINT with the Clerk of Court using the CM/ECF system,

which will automatically send email notification of such filing to the following

counsel of record:

Michael R. Smith, Esq.Benjamin Lee, Esq.KING & SPALDING LLP1180 Peachtree Street, N.E.Atlanta, Georgia 30309-3521(404) 572-4600(404) 572-5100 Faxmrsmith kslaw.comblee(kslaw.com

Attorneysfor Defendants


This 3rd day of July, 2008.

/s/ Michael J. Gorby

Michael J. Gorby, Esq.

Mary Donne Peters, Esq.

GORBY, PETERS &

ASSOCIATES, P.C.Two Ravinia Drive, Suite 1500Atlanta, GA 30346-2104Telephone: (404) 239-1150Fax: (404) [email protected]@gorbyreeves.com

Is/ Merrill G. DavidoffMerrill G. Davidoff, Esq.Michael Dell'Angelo, Esq.Lane L. Vines, Esq.BERGER & MONTAGUE, P.C.1622 Locust StreetPhiladelphia, PA 1.9103Telephone: (215) 875-3000Fax: (215) [email protected]@[email protected]

Local Counselfor Lead Plaintiff Lead Counselfor Lead PlaintiffRobert A. Brown and the Proposed Robert A. Brown and the ProposedClass Class

Documents

In Re NetBank, Inc. Securities Litigation 07-CV-02298 ...securities.stanford.edu/filings-documents/1038/NTBKPK_01/200873_r... · Case 1:07-cv-02298-BBM Document35 Filed 07/03/2008