SEC files securities fraud complaint against Countrywide executives

In what may be just the first in a series of charges related to the current financial crisis, the SEC has announced the filing of securities fraud charges against former Countrywide Financial CEO Angelo Mozilo, former COO and president David Sambol and former CFO Eric Sieracki. They are charged with deliberately misleading investors by falsely assuring investors that Countrywide was primarily a prime quality mortgage lender that had avoided the excesses of its competitors, while in reality, it had undertaken significant credit risks to build and maintain the company's market share. The complaint alleges that Countrywide's 10-Ks for 2005, 2006 and 2007 claimed that Countrywide "manage[d] credit risk through credit policy, underwriting, quality control and surveillance activities," that its 2005 and 2006 annual reports stated that the company ensured its "access to the secondary mortgage market by consistently producing quality mortgages," and that its 2006 annual report claimed that Countrywide had "prudently underwritten" its Pay-Option ARM loans. In reality, the complaint alleges, Countrywide had taken on enormous credit risks. The complaint alleges that the three charged were aware of these risks, as reflected in a series of internal emails from Mozilo identifying the potential dangers inherent in various Countrywide loan products and describing the rapid deterioration of the quality of its loans and securitizations, made increasingly precarious as defaults and delinquencies increased. The SEC's complaint claims that Mozilo believed that the risk was so high and that the secondary market had so mispriced Pay-Option ARM loans that he repeatedly urged that Countrywide sell its entire portfolio of Pay-Option loans. However, these concerns were allegedly not addressed in Countrywide's disclosure. For example, the complaint states that, while Countrywide provided statistics about its loan originations that reported the percentage of loans in various categories, the descriptions of "prime non-conforming" and "nonprime" loans did not adequately reveal the types of loans that were included in those categories. The complaint states that there was no definition of "nonprime" and that nothing in the description of "prime non-conforming" informed investors that Countrywide did not consider any FICO credit score to be too low to be categorized within "prime, " or that it included "Alt-A loans" or Pay-Option ARMS. Similarly, where these types of loans were below the loan limits established by Fannie Mae and Freddie Mac, they would have been categorized by Countrywide as "prime conforming loans."

The SEC also charged that Mozilo engaged in insider trading through the establishment of a series of 10b5-1 plans in October, November and December 2006 while he was in possession of material, non-public information concerning Countrywide's increasing credit risk and expected poor performance. These sales resulted in profits to Mozilo of $140 million.

Here is the press release, the complaint and a few excerpts from the Mozilo emails. Both the complaint and the email excerpts are recommended reading for those who want to get an inside view of how the crisis originated.