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Sep 17
2010

Countrywide lawsuit cleared for trial

Posted by Stephen Taub in sub-primeSecurities and Exchange CommissionsecmortgagesCountrywide Financialcompliance

Stephen Taub

One of the most high profile players in the subprime lending crisis is going to trial in October.

A US District Judge in Los Angeles denied a motion to dismiss the civil charges against three former top executives at Countrywide Financial Corp.--Chief Executive Officer Angelo Mozilo, chief operating officer and president David Sambol and chief financial officer Eric Sieracki.

They were charged with deliberately misleading investors about the significant credit risks being taken in efforts to build and maintain the company's market share. Mozilo was also charged with insider trading for selling his Countrywide stock based on non-public information for nearly $140 million in profits.

"It remains to be seen whether the Securities and Exchange Commission will be able to convince a jury that defendants' statements were indeed misleading and material," Walter said in his decision, according to Bloomberg. "At the summary judgment stage, the judge's function is not himself to weigh the evidence and determine the truth of the matter."

Mozilo co-founded Countrywide in 1969. It eventually became the country's largest mortgage lender and is perhaps the name most prominently linked to the housing bubble triggered by very shaky subprime mortgages.

The SEC's alleges that the three men misled the market by falsely assuring investors that Countrywide was primarily a prime quality mortgage lender that had avoided the excesses of its competitors.


According to the regulator, from 2005 through 2007, Countrywide engaged in an unprecedented expansion of its underwriting guidelines and was writing riskier and riskier loans, which these senior executives were warned might ultimately curtail the company's ability to sell them. Countrywide was required to disclose these important trends to its investors in the Management Discussion and Analysis portion of its SEC filings, but failed to do so.

"Countrywide portrayed itself as underwriting mainly prime quality mortgages using high underwriting standards," Robert Khuzami, Director of the SEC's Division of Enforcement, said last year in a press release. "But concealed from shareholders was the true Countrywide, an increasingly reckless lender assuming greater and greater risk."

Khuzami said Mozilo privately described one Countrywide product as "toxic," and said another's performance was so uncertain that Countrywide was "flying blind."

The SEC alleges that Mozilo, Sambol, and Sieracki actually knew, and acknowledged internally, that Countrywide was writing increasingly risky loans and that defaults and delinquencies would rise as a result, both in loans that Countrywide serviced and loans that the company packaged and sold as mortgage-backed securities.

According to the SEC's complaint, Countrywide developed what was internally referred to as a "supermarket" strategy that widened underwriting guidelines to match any product offered by its competitors. By the end of 2006, Countrywide's underwriting guidelines were as wide as they had ever been, and Countrywide made an increasing number of loans based on exceptions to those already wide guidelines, even though exception loans had a higher rate of default.

The SEC's complaint alleges that Mozilo believed that the risk was so high that he repeatedly urged that Countrywide sell its entire portfolio of Pay-Option loans. Despite these concerns about the increasing risks that Countrywide was undertaking, Mozilo, Sambol, and Sieracki hid these risks from the investing public, according to the regulator.

As for the insider trading charges, the SEC alleges Mozilo established four executive stock sale plans for himself in October, November, and December 2006 while he was aware of material, non-public information concerning Countrywide's increasing credit risk and the expected poor performance of Countrywide-originated loans. From November 2006 through August 2007, Mozilo exercised more than 5.1 million stock options and sold the underlying shares for total proceeds of nearly $140 million, underwritten trading plans adopted in late 2006 and early 2007.

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