'Mozilo clause' drawing blood: he cashed in during subprime meltdown, critics say.

A controversial stock trading plan has given Countrywide Financial Corp. Chief Executive Angelo Mozilo a new distinction.

He now has a securities law named after him, at least by some.

Dubbed the "Mozilo clause" by some critics, Securities and Exchange Commission rule 10b5-1 enables company insiders to sell company stock provided they pledge that they don't have "material" inside information at the time they set up a 10b5-1 plan. Then they can sell stock in the future, so long as the sales are in line with some schedule--perhaps price or time triggers--as set out in the plan. If the executives come across material nonpublic information as they sell stock, the plan can act as a defense against insider-trading charges.

Hundreds of top executives have such plans, but Mozilo is a particularly heavy user. He has sold more than $100 million worth of shares since August and $50 million in the last three months, according to regulatory filings. In the last week and a half alone, Mozilo sold nearly 200,000 shares for about $9 million. All those sales were under one of his several plans.

Many of those sales occurred in advance of sour news for Mozilo's Calabasas-based company, which is a major lender in the subprime sector that melted down in February and March.

Countrywide's stock hit a recent peak in early February, when it traded for just under $45 a share, but has sagged since, hitting a recent low of less than $33 early this month. On Thursday, Countrywide reported a 37 percent drop in first quarter earnings and trimmed its earnings outlook going forward.

"This Mozilo clause is clearly a loophole in the entire trading system," said Alexandra Higgins, a senior compensation analyst for the Corporate Library, a governance research firm. "It's obviously a way for executives like him to enrich themselves, and it's highly convenient that most of these transactions tend to coincide with a negative earnings release and that option exercise dates happen to come just in time or before announcements."

A Countrywide spokesman declined to make specific comments on the issue.

Bad timing

SEC filings reveal that all of Mozilo's transactions since February were part of a 10b5-1 plan set up in December of 2006 and amended on February 2, when the subprime lending meltdown was picking up steam. (Earlier sales were made under previous 10b5-1 plans.)

Countrywide would not comment on the nature of the February amendment but it's clear that the bulk of the proceeds from Mozilo's estimated 64 transactions over the last 12 months came within the period of February 1 through last week.

Most of Mozilo's more recent transactions involved options that were exercised and sold for a profit in the same day. For instance, on April 23, Mozilo exercised options on 70,000 shares, essentially buying them for $9.60 each and then selling them the same day for $37.33. This came three days after he exercised a separate block of 46,000 options at $10.89 and sold them for $37.84.

"A lot of executives are now setting up these plans because they see that this gives insiders a lot more flexibility and better returns," said Dan Grant, a 10b5-1 specialist and vice president of brokerage firm William Blair & Co. "In theory, you can sign up today and trade tomorrow but the best practice is to create as much daylight as you can between setting up your plan and trading your shares."

The SEC originally created the measure in 2000 to discourage insider trading violations. But the provision was utilized by former Enron chairman Ken Lay to skirt insider trading charges and has come under increased scrutiny with the recent insider trading conviction of Joseph Nacchio, the former chief executive of Qwest Communications.

Scholarly evidence suggests that executives who use the plans have an advantage over colleagues who don't. For instance, a December study by Stanford University Accounting Professor Alan Jagolinzer, found that stock sales by participating executives "systematically" come after positive public disclosure and before negative information.

The study goes on to suggest that managers, who use the plan as a "safe harbor," beat the market at a rate of 6 percent as opposed to executives without plans who only beat the market by 1.9 percent.

'A murky rule'

When it comes to what could be construed as insider wading, there's a thin line between "insider trading with a capital I.T. and the kind that happens all the time," said Russ Frandsen, an L.A.-based securities lawyer for Reed Smith LLP.

"If you're doing your job right as an executive, you know everything about your company. You'll be in possession of material information all the time," he said.

The SEC has long struggled with enforcing insider trading rules as well as establishing that sellers had what they call "guilty knowledge" of what they were doing. The regulator mostly relies on settlements like the one last year from two former Countrywide vice presidents who were accused of shorting company stock ahead of a negative earnings release.

"We have hundreds of investigations underway right now involving backdating and insider trading, unfortunately there's no universal litmus test," said SEC spokesman Mike Nestor.

Nestor wouldn't say whether the regulator was monitoring Countrywide's activities but said any time a high volume of trades occurs in an industry with tumultuous events, it bears watching.

However, in a recent speech, Linda Thomsen, the SEC enforcement chief, said the agency was looking "hard" into whether the rule should be amended because of abuse.

Even if the insider trades are totally benign, Countrywide's headaches are far from over. The Louisiana Municipal Police Employees Retirement System is asking Delaware's Chancery Court to force Countrywide to turn over documents regarding policies and procedures around stock and options packages for company executives.

Countrywide's attorney in the case, Brian Pastuszenski, says the fund's suspicions are based on the premise that returns from options exercised by executives are higher than average returns.

"The financial results you're seeing (on stock sales) are the product of chance," Pastusenski told the court.

However, corporate governance advocates say that the rule should be amended because it simply raises too many questions that can't be answered without extensive investigation.

"It's just a murky rule and an even murkier plan," said Zach Gast of the Center for Financial Research and Analysis, a forensic accounting consultancy in Maryland.

"A guy like Mozilo could in fact be squeaky clean but his timing couldn't be worse. Either way there's no way to know much until everything plays out."

BY JABULANI LEFFALL

Staff Reporter