Angelo Mozilo, who built the largest U.S. mortgage lender, was charged with securities fraud and insider trading on Thursday, making him the most prominent defendant in investigations into the U.S. subprime mortgage crisis and housing bust.
The U.S. Securities and Exchange Commission said Mozilo, 70, co-founder of Countrywide Financial Corp and poster boy for the U.S. mortgage meltdown, made more than $139 million in profits in 2006 and 2007 by exercising 5.1 million stock options and selling the underlying shares.
The SEC said in its civil lawsuit, filed in Los Angeles on Thursday, that in one instance, the day before he set up a stock trading plan on September 25, 2006, Mozilo sent an email to two Countrywide executives that said: We are flying blind on how these loans will perform in a stressed environment of higher unemployment, reduced values and slowing home sales.
Those executives, then Countrywide President David Sambol, 49, and Chief Financial Officer Eric Sieracki, 52, were charged by the SEC with knowingly writing riskier and riskier subprime loans that they had a limited ability to sell on the secondary mortgage market.
Countrywide was ground zero in the mortgage and housing industry meltdown that built up momentum from late 2006 and has cost U.S. banks hundreds of billions of dollars -- if not trillions -- in credit losses and writedowns.
Lawyers said the SEC's approach in the Countrywide case, which focuses on the failure to disclose vital information about the deteriorating quality of company assets, may become a template for the agency as it seeks to bring cases against executives at other financial institutions that blew up during the crisis.
The SEC has been under pressure to bring a high-profile case after it was blasted for missing Bernard Madoff's $65 billion investment fraud. New SEC chief Mary Schapiro has vowed to bring cases swiftly and has warned that there would be no sacred cows.
The SEC clearly will use information known to corporate executives but not disclosed publicly as a template for bringing charges in connection with the mortgage bust, said Jacob Frenkel, a former SEC enforcement attorney now in private practice at Shulman Rogers.
At one stage, Countrywide, which was based in Calabasas, California, was writing almost one out of every six American mortgages. The lawsuit said that by September 2006, Countrywide estimated it had a 15.7 percent share of the market, up from 11.4 percent at the end of 2003.
Bank of America Corp bought Countrywide last July 1 for $2.5 billion, less than a tenth of what it had been worth in early 2007.
On Thursday, the SEC said that all three executives failed to tell investors how dependent Countrywide had become on its ability to sell subprime mortgages on the secondary market. All three were accused of hiding from investors the risks they took to win market share.
While Countrywide boasted to investors that its market share was increasing, company executives did not disclose that its market share increase came at the expense of prudent underwriting guidelines, the lawsuit said.
TWO COMPANIES -- INSIDE AND OUTSIDE
Credit losses experienced by Countrywide in 2007 were foreseen as early as 2004, the SEC claimed in the lawsuit.
It said Countrywide's senior officers were repeatedly warned that several aggressive features of Countrywide's guidelines, such as reduced documentation loans, significantly increased the company's risk.
This is a tale of two companies, the SEC's director of enforcement, Robert Khuzami, told reporters. One, that investors from the outside saw. It was allegedly characterized by prudent business practices and tightly controlled risk.
But the real Countrywide, which could only be seen from the inside, was one buckling under the weight of deteriorating mortgages, lax underwriting, and an increasingly suspect business model.
The lawsuit cited an April 2006 email from Mozilo that said in conversations with Sambol he called a particularly high-risk mortgage the milk of the business. But Mozilo, in the same memo, said he considered that product line to be the poison.
Mozilo's stock sales were made under four prearranged trading plans prepared during the time period, the SEC said.
The fact that the trading plan did not ward off insider trading charges against Mozilo should be a warning to heads of other firms, said Robert Mintz, a former federal prosecutor and now head of white-collar defense at McCarter & English.
The message ... is that no plan is fail-safe and that any CEO who had any of these preset stock selling plans has to continue to be vigilant in making decisions about how to alter those plans going forward, Mintz said.
Mozilo, a butcher's son from the Bronx in New York City who co-founded Countrywide in 1969, had publicly expressed confidence in the company's prospects right up to the time of its takeover by Bank of America.
Mozilo's attorney, David Siegel, said in a statement that the lawsuit does not reflect a balanced or fair consideration of the facts or the law and that the stock trades at issue were entirely lawful.
The SEC's allegations that Mr. Mozilo supposedly knew about some undisclosed risk to certain loans made by Countrywide also are demonstrably false, Siegel said.
The mix and risks of Countrywide's loan portfolio and its underwriting standards were well disclosed to and understood by the marketplace.
Sambol's attorney, Walter Brown, called the lawsuit baseless and motivated by tremendous political pressure the SEC is facing as a result of the Madoff debacle.
The SEC wrongly asserts that Countrywide's disclosures to its investors regarding its lending criteria should have been more extensive, and that Mr. Sambol is somehow responsible for insufficient disclosure, Brown said in a statement.
Through his attorney Nicolas Morgan, Sieracki also denied violating any securities laws.
Mr. Sieracki unequivocally demonstrated his belief in the accuracy of Countrywide's disclosures with his own money, and ultimately lost millions like other investors, Morgan said in a statement.
The FBI and U.S. Attorney in Los Angeles are actively probing criminal insider trading and fraud allegations against Mozilo but are not close to an indictment, sources said recently.
For the SEC lawsuit, click http://www.sec.gov/litigation/complaints/2009/comp21068.pdf
(Reporting by Gina Keating and Rachelle Younglai; Additional reporting by Karey Wutkowski; Editing by Toni Reinhold, Edwin Chan, Gary Hill)