June 4 (Bloomberg) -- Former Countrywide Financial Corp. Chief Executive Officer Angelo Mozilo and two of his top deputies were sued by the Securities and Exchange Commission for allegedly hiding the home lender’s deteriorating finances as the subprime mortgage crisis unfolded.

While publicly reassuring investors about the quality of his loans, Mozilo issued “dire” internal warnings and engaged in insider trading accelerating stock sales to reap about $140 million, the agency said in the suit at Los Angeles federal court. In one e-mail, he described a “particularly profitable subprime product as ‘toxic.’” He also wrote that Countrywide was “flying blind” and had “no way” to determine the risks of some adjustable-rate mortgages, the SEC said.

“Each of the defendants was aware, but failed to disclose, that Countrywide’s current business model was unsustainable,” the agency wrote in the suit, which also named former Chief Operating Officer David Sambol, 49, and former Chief Financial Officer Eric Sieracki, 52. All three defendants denied the agency’s claims.

Mozilo, 70, is the most prominent executive targeted by U.S. regulators examining the subprime mortgage crisis. Mozilo co-founded Countrywide in 1969 and built it into the nation’s biggest mortgage lender, helping trigger the subprime bubble by offering loans to customers with below-average credit scores. Mounting loan defaults slashed the company’s stock price, prompting its sale to Bank of America Corp. last year.

Increasingly Risky Loans

The lender had expanded its underwriting guidelines and wrote increasingly risky loans from 2005 through 2007, even as it reassured investors it focused mainly on so-called prime quality mortgages, the SEC said.

“This is the tale of two companies,” SEC enforcement chief Robert Khuzami said. “Concealed from shareholders was the true Countrywide, an increasingly reckless lender assuming greater and greater risk.”

The SEC wants the court to levy unspecified fines, force the defendants to forfeit profits, and bar them from serving as officers or directors. Mozilo’s stock-sale profit came while exercising stock options from November 2006 until August 2007, the agency said.

‘Without Merit’

“The complaint does not tell the whole story of either internal communications or the public disclosures,” and the SEC’s claims about the stock sales are “without merit,” Mozilo’s lawyer, David Siegel, at Irell & Manella LLP in Los Angeles, said 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 filed its case because of political pressure after its own “well-publicized enforcement failures,” said Walter Brown, Sambol’s attorney, in a statement. “Making groundless allegations and losing in court will not help the SEC restore its reputation.”

Countrywide made detailed credit risk disclosures, Brown 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 provided information that the SEC now says was absent from Countrywide’s filings, Brown said.

Sieracki denies wrongdoing and bought, rather than sold, Countrywide stock during the period the SEC claims he believed the company was withholding information from the market, said his attorney, Shirli Weiss.

“No one, not the government nor the most sophisticated of market analysts, foresaw the precipitous and pervasive economic crisis that affected virtually all markets and businesses in the country, including Countrywide’s,” Weiss said in a statement. “Mr. Sieracki’s actions and statements are completely inconsistent with fraud, a fact the SEC will not be able to contradict.”

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

Last Updated: June 4, 2009 17:52 EDT