June 5 (Bloomberg) -- The day after Countrywide Financial Corp. Chief Executive Officer Angelo Mozilo arranged to start $139 million in stock sales, he told two top deputies there was “no way” to value one of its most popular mortgages.

“We are flying blind on how these loans will perform in a stressed environment of higher unemployment, reduced values and slowing home sales,” he wrote in a 2006 e-mail released yesterday by the Securities and Exchange Commission. “We have no way, with any reasonable certainty, to assess the real risk of holding these loans on our balance sheet.”

Mozilo, 70, co-founded Countrywide in 1969 and built it into the nation’s biggest home lender. Yesterday he became the most prominent executive targeted by the SEC in a regulatory autopsy of the subprime crisis. He, and the two deputies who received his e-mails on so-called pay-option ARM loans, were accused of hiding deteriorating lending standards before the housing bubble burst. The agency quoted Mozilo’s messages, arguing he avoided losses by making illegal insider trades.

“While hiding his hand from investors, Mozilo was actively taking his own chips off the table” SEC enforcement chief Robert Khuzami told journalists in Washington. “Concealed from shareholders was the true Countrywide, an increasingly reckless lender assuming greater and greater risk.”

The defendants, including former Chief Operating Officer David Sambol, 49, and Chief Financial Officer Eric Sieracki, 52, deny wrongdoing. Their lawyers accused the SEC of succumbing to political pressure and cherry-picking quotes from e-mails to build a case.

Not ‘The Whole Story’

“The complaint does not tell the whole story of either internal communications or the public disclosures,” said Mozilo’s lawyer, David Siegel, at Irell & Manella LLP in Los Angeles, in a statement. “The mix and risks of Countrywide’s loan portfolio and its underwriting standards were well disclosed to and understood by the marketplace.”

The agency is pursuing the lender’s executives because of its “well-publicized enforcement failures” in other cases, said Walter Brown, Sambol’s attorney. “Making groundless allegations and losing in court will not help the SEC restore its reputation,” Brown said.

Countrywide made detailed credit-risk disclosures, he said, and investors and rating companies knew that the company had “liberalized” its lending practices, as had almost all other lenders at the time. Sambol disclosed details about subprime products, the risks they carried and other information that the SEC now says was absent from filings, Brown said.

Stock Purchased

Sieracki bought Countrywide stock during the period the SEC claims he believed the company was withholding information from the market, said his lawyer, Shirli Weiss. He said Sieracki didn’t violate securities law and called the lawsuit “completely without merit.”

Countrywide helped trigger the subprime bubble by offering loans to people with below-average credit scores. From 2005 through 2007, the lender expanded its underwriting guidelines and wrote increasingly risky loans, while reassuring investors it focused mainly on so-called prime quality mortgages, the SEC said. Mounting defaults ultimately slashed its stock price, prompting its sale to Bank of America Corp. last year.

“It’s the first case of true notoriety” to target fraudulent practices in mortgage lending, said Jacob Frenkel, a former SEC lawyer now at Shulman Rogers Gandal Pordy & Ecker PA in Rockville, Maryland. “It clearly signals the opening of the spigot to both civil and the criminal cases.”

Subprime Lenders

Starting in 2004, Countrywide began aggressively matching loan programs being offered by subprime lenders, the SEC said. By 2006, more than half of its loans either didn’t meet industry lending standards or were loans to people with less than pristine credit, the agency’s complaint said.

The company increasingly allowed exceptions to its underwriting guidelines to facilitate its matching program, the regulator said. From early 2006, Countrywide lifted a requirement that exceptions to its underwriting rules could only be made if there were other factors that offset the risks of making the loan, the agency said.

Company regulatory filings in 2005, 2006 and 2007 that said Countrywide managed risks through underwriting standards were false, the SEC said, because a significant portion of loans were being made as exceptions to its internal rules.

Hidden Risks

The company’s descriptions of these loans in regulatory filings didn’t reveal the increased risks, the SEC said. Countrywide didn’t say that loans categorized as not meeting industry lending standards included no-document and stated- income loans and it didn’t disclose loans to borrowers with recent bankruptcies, the SEC said.

Worried about the so-called pay-option ARMs, which offered low introductory monthly payments that could later balloon, Mozilo urged Sambol to sell the portfolio, saying the company was “flying blind” on how the loans would perform in a sagging economy.

Sambol’s attorney disputes that his client didn’t disclose to investors that the Countrywide’s business was shifting to so-called “non-conforming loans” and pointed to 2005 and 2006 investor presentations where Sambol said the company was aggressively matching rival’s products.

“Those e-mails conveniently omit the responses and fail to entirely reveal the comprehensive analysis that Countrywide undertook,” said Brown, Sambol’s attorney, in a telephone interview.

Mozilo’s Holdings

While Mozilo acknowledged in e-mails the risks associated with Countrywide’s loans and the company’s need to sell the option-ARM portfolio, he was simultaneously arranging to dump his own holdings, according to the SEC’s complaint.

In the final months of 2006 he began establishing four sale plans “while in possession of material, non-public information concerning Countrywide’s increasing credit risk,” the SEC said. From those plans, he exercised over 5.1 million stock options and sold the underlying shares for total proceeds of almost $139 million.

The SEC authorized such plans in 2000 to let executives sell shares without the appearance of tapping current information on their companies. Still, the SEC may make its case against Mozilo, if it can show he had significant information that the market lacked when he arranged his sales, said Robert Hillman, a securities law professor at the University of California, Davis.

“These plans are not a get-out-of-jail card,” he said.

The company has repeatedly come under fire from U.S. officials including Senator Charles Schumer for lax lending standards and its compensation packages.

“Under Angelo Mozilo, Countrywide became the poster child for unconscionable behavior by mortgage lenders,” Schumer, a New York Democrat, said in a statement yesterday. “This is a company that turned the American dream into a nightmare for thousands of innocent borrowers, and misled their shareholders along the way.”

The case is Securities and Exchange Commission v. Mozilo et al, 09-3994, U.S. District Court, Central District of California (Los Angeles).

To contact the reporters on this story: David Scheer in New York at dscheer@bloomberg.net; Karen Gullo in San Francisco at kgullo@bloomberg.net; Ari Levy in San Francisco at alevy5@bloomberg.net.

Last Updated: June 5, 2009 00:00 EDT