Mozilo case sparks new scrutiny of CEO trading plans

By Martha Graybow - Analysis

NEW YORK (Reuters) - The insider trading case against home loan entrepreneur Angelo Mozilo is sparking renewed questions about potential abuse of stock selling plans that were intended to be one of corporate executives' best defenses against accusations of improper trading.

These preset trading plans have been under heightened scrutiny since a 2006 academic paper found that corporate insiders' stock sales under those plans turned out to be particularly well-timed. The study raised suspicions that the plans could be manipulated.

Now, with the U.S. Securities and Exchange Commission suing Mozilo, the former chief of Countrywide Financial Corp, in its first major court case involving these plans, legal experts say they think more enforcement actions could be on the way.

"They are looking at this area and there may be more" such cases down the road, said Katayun Jaffari, a partner at law firm Saul Ewing in Philadelphia and co-chairwoman of the securities transactions practice group. "There certainly is that opportunity now that there is some precedent."

Experts also say companies are taking a closer look at disclosure involving these arrangements, known as 10b5-1 plans after the SEC rule that allows them.

"On their face, these arrangements looked like a good solution to any problem of short-term manipulation that an executive looked prone to," said Todd Gershkowitz, senior vice president of pay advisory firm Farient Advisors in New York.

But "they can be modified and changed and terminated in relatively short order," he said. "It turns out that they may not be achieving their original purpose."

SYSTEMATIC SELLING

The plans were created by a 2000 SEC rule change, after conflicting court rulings had caused confusion about what constituted insider trading. They are used by hundreds of executives and board members throughout corporate America.

The plans are designed to give participants a way to systematically sell their company stock through written, preset trading agreements adopted at a time when they have no material inside knowledge about the business, such as details of upcoming profit results or a merger announcement.

The potential for wrongdoing usually comes when executives decide to stop any trading in the plans or modify the terms, experts say. Changing the plans is permitted, but not if done in bad faith and with insider knowledge.

That is the crux of the allegations against Mozilo, whom the SEC said netted more than $139 million in illicit profits from selling his vast Countrywide holdings through 10b5-1 plans adopted in late 2006 and altered in early 2007.

The SEC contends Mozilo kept key information from investors about the company's increasingly risky lending activity while taking "his own chips off the table." He is accused of approving one plan's creation just a day before warning colleagues that Countrywide was "flying blind" on how its mortgage loans would perform.

The agency, which cannot bring criminal charges, has sued Mozilo in a civil lawsuit that seeks financial penalties. He has denied any wrongdoing.

RED FLAGS