Mozilo Not Innovative Enough To Avoid SEC’s Fire

If he had played his cards right, former Countrywide Mortgage CEO Angelo Mozilo could have dodged the insider trading rap from the SEC with one of Wall Street's house specialties: structured finance. Investment brainiacs have figured out a way to neuter any kind of personal risk for America's top executives, but for some reason Mozilo abstained

Just to recap: Mozilo and his two top lieutenants, former Chief Operating Officer David Sambol and former Chief Financial Officer Eric Sieracki, were slapped yesterday with civil fraud charges for hiding critical information about the deteriorating state of affairs at what was once the nation's No. 1 mortgage lender. Mozilo sold $139 million of stock just before the company and its stock price collapsed. The feds in L.A. are looking into criminal charges as well.

Mozilo could have possibly dodged the insider trading charges by using a gimmick known on Wall Street as a prepaid variable forward contract. It's a shady if legal practice that enables CEOs and other top managers to protect the value of their stock compensation regardless of performance. Stock compensation, of course, allegedly aligns management's interests with those of shareholders. Prepaid variable forward contracts thwart that goal by allowing managers to lock in a value on the stock over a set period of time, say five years. If the stock loses value during that time, the brokerage swallows the losses. If the stock gains, the brokerages share only a portion of the good fortune. And guess what? The Wall Street Journal reports that a new study shows corporate executives manage to time these contracts brilliantly. Heads the CEO wins, tails the brokerage loses. Never mind the shareholders.

Incentives like these gone awry are the real villains of the current economic mayhem. Countrywide is the crucible. Every player involved was rewarded for bad behavior: from top executives to brokers who got commissions for making loans whether or not borrowers were likely to repay. Borrowers, many naive, got a chance to participate in a rigged game of Let's Make a Deal. Behind every door was a fabulous house, no income verification needed. And even when Countrywide collapsed into the arms of Bank of America (BAC), the guys who messed up got great big pats on the back: Both Sambol and Sieracki received retention bonuses.

The stock sales, bonuses, subprime loans—they were all so easy to pull off because no real hard cash was involved. In an update to his best-seller Predictably Irrational, Dan Ariely reveals that people rarely steal cash; too obviously wrong. Things, goods—that's another matter. So when Ariely placed six-packs of Coca Cola in MIT dormitory refrigerators as part of an experiment, the cans disappeared within 72 hours. But no one touched plates holding six one-dollar bills that he had also placed in the fridges.

At Countrywide, mortgage brokers and borrowers falsified paperwork. Mozilo called the loans "poison," but he never walked into someone's house and started stuffing bags with their $100 bills. He sold stock. What's the harm in that?