On the eve of trial the SEC settled one of its most significant market crisis cases, SEC v. Mozilo, Case No. CV 09-03994 (C.D. Cal. Filed June 4, 2009). The case is significant because it is one of the few which pierces to the sub-prime center of the market crisis and names senior executives as defendants.

The settlement is being trumpeted by the SEC PR machine as a total triumph. There is no doubt that the terms of the deals with the three individual defendants, former CEO Angelo Mozilo and his two top lieutenants, former COO David Sambol and former CFO Eric Sieracki, are significant. Key terms of the settlements, which have been approved by the court, are:

  • Mr. Mozilo consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(a). He will also pay disgorgement of $45 million, including prejudgment interest, and a civil penalty of $22.5 million for a total financial settlement of $67.5 million according to the SEC press release (here). The former CEO also agreed to the entry of a permanent officer/director bar.
  • Mr. Sambol consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(a). He will disgorge $5 million, including prejudgment interest, and pay a civil penalty of $520,000. The former COO also agreed to a three year director/officer bar.
  • Mr. Sieracki consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) and (3) and an order barring him from practicing before the Commission for one year. He also agreed to pay a civil penalty of $130,000.

The complaint, discussed here, details a series of false statements by each of the three defendants over a period of years not just to cover up the deteriorating financial condition of the huge sub-prime lender as the market crisis unfolded, but to affirmatively mislead investors. Beginning as early as the first quarter of 2005, the Commission repeatedly cites quarterly and annual reports which falsify and conceal the deteriorating financial condition of the one-time market giant. The rosy picture painted for the public stands in stark contrast to the internal e-mails and other documents which highlight the knowledge of the defendants about the difficult financial straights of their company.

As the events which lead to the market crisis unfolded, Countrywide’s disclosure control committee reviewed and analyzed the increasingly desperate financial condition of the sub-prime lender, according to the complaint. This is precisely the process Sarbanes Oxley envisioned with its CEO and CFO certification and other requirements. The group, which included the defendants, knew the true, cancerous financial condition of the company. Yet, according to the SEC, CEO Mozilo and CFO Sieracki executed certifications attesting to the financial health of the company – precisely the opposite of what SOX sought.

The complaint concludes with details about the securities trading of defendants Mozilo and Sambol. The former sold shares valued at $260 million, while sales by the latter totaled $40 million. Mr. Mozilo, the complaint claims, engaged in insider trading, “from November 2006 through October 2007 . . . [exercising] over five million stock options and . . . [selling] the underlying shares pursuant to the four sales plans, realizing profits of over $139 million.” (Cmplt. ¶ 124).

The complaint alleges violations of: Securities Act Section 17(a) by each of the defendants; Exchange Act Sections 10(b) by each of the defendants; Exchange Act Sections 13(a) by each of the defendants; and Rule 13(a)-14 by Messrs. Mozilo and Sambol.

Comparing the claims in the complaint to the settlements is instructive:

  • As to Mr. Mozilo, the so-called $67.5 million total financial settlement is a bit of an over statement. In fact most of the $45 million in disgorgement is being paid to settle private litigation. In the SEC case, Mr. Mozilo is paying $20 million in disgorgement (including prejudgment interest). Both amounts stand in stark contrast to the Commission’s claims that the executive sold stock worth $260 million and had insider trading “gains” as the complaint described them of $139 million. While it is unclear whether these amounts represent the trading profits or are gross sales figures, they clearly dwarf the settlement amounts. They also stand in stark contrast to the hundreds of millions in compensation Mr. Mozilo was paid. Finally, there is no apparent reason for dropping the claim for injunctive relief under Rule 13(a)-14 in view of the facts alleged in the complaint.
  • As to Mr. Sambol, the settlement includes $5 million in disgorgement (including prejudgment interest). Again however, this amount stands in stark contrast to the trading by the former COO which, according to the complaint, totaled $40 million.
  • As to Mr. Sieracki, the Commission dropped its Securities Act Section 17(a) and Exchange Act Section 10(b) scienter-based fraud claims in favor of an injunction based on Section 17(a)(2) & (3), negligence fraud. The Commission also dropped its claim under Rule 13(a)-14. Yet, the complaint is replete with claims that Mr. Sieracki as CFO acted intentionally and knew the true financial condition of the company which was not disclosed.

Overall, the settlement in Mozilo makes good headlines with big, at times puffed, numbers. In the end however, the results contrast sharply with the claims. If the allegations in the Commission’s complaint depict the underlying facts – a point which has previously been raised in, for example, the Citigroup (here) and Bank of America (here) settlements – the resolution in Mozilo raises significant questions.