Mozilo's Response in Support of The Motion To Dismiss

Case 2:09-cv-03994-JFW-MAN Document 321 Filed 08/23/10 Page 1 of 19 Page ID
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1 IRELL & MANELLA LLP

David Siegel (101355) (dsiegel@irell.com)
2 Daniel P. Lefler (151253) (dlefler@irell.com)
Randall L. Jackson (244545) (rjackson@irell.com)
3 1800 Avenue of the Stars, Suite 900
Los Angeles, CA 90067
4 Telephone: (310) 277-1010
Facsimile: (310) 203-7199
5
WILLIAMS & CONNOLLY LLP
6 Brendan V. Sullivan, Jr. (Pro Hac Vice)
David D. Aufhauser (Pro Hac Vice)
7 Tobin J. Romero (Pro Hac Vice)
725 Twelfth Street, N.W.
8 Washington, D.C. 20005
Telephone: (202) 434-5000
9 Facsimile: (202) 434-5029
10 Attorneys for Defendant
Angelo Mozilo
11
[Additional counsel on signature page]
12
13 UNITED STATES DISTRICT COURT
14 CENTRAL DISTRICT OF CALIFORNIA
15 WESTERN DIVISION
16 SECURITIES AND EXCHANGE ) Case No. CV 09-03994 JFW (MANx)
COMMISSION, )
17 ) JOINT REPLY MEMORANDUM
Plaintiff, ) OF POINTS AND AUTHORITIES
18 ) IN SUPPORT OF DEFENDANTS’
vs. ) MOTIONS FOR SUMMARY
19 ) JUDGMENT OR ADJUDICATION
ANGELO MOZILO, DAVID )
20 SAMBOL, AND ERIC SIERACKI, ) Date: August 30, 2010
) Time: 1:30 p.m.
21 Defendants. ) Ctrm: 16
) Judge: Hon. John F. Walter
22 )
)
23 )
) Pre-Trial Conf: October 1, 2010
24 ) Trial: October 19, 2010
25
26
27
28
JOINT REPLY MEMORANDUM OF POINTS AND
AUTHORITIES IN SUPPORT OF DEFENDANTS’
IRELL & MANELLA LLP
A Registered Limited Liability
MOTIONS FOR SUMMARY JUDGMENT
Law Partnership Including
Professional Corporations
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1 TABLE OF CONTENTS
2 Page
3 I. INTRODUCTION...........................................................................................1
4 II. ARGUMENT ..................................................................................................1
5 A. Defendants Are Entitled To Summary Judgment Of The
SEC’s Claims Concerning Countrywide’s Originate-To-
6 Distribute Business ...............................................................................1
7 1. There Is No Triable Issue Of Fact About Whether
Countrywide Stockholders Knew About Guideline
8 Expansion....................................................................................1
9 2. There Is No Triable Issue About Whether The
Alleged Omissions Concerning Exception Loans
10 And Quality Control Audits Were Misleading Or
Material.......................................................................................5
11
3. The SEC Has Come Forward With No Evidence
12 That Undisclosed Loan Quality Problems Disrupted
The Originate-To-Distribute Business .......................................7
13
4. The Challenged Statements About Loan Quality Are
14 Nonactionable Puffery ..............................................................10
15 5. The Requirements Of Regulation S-K Item 303 Do
Not Give Rise To Fraud Liability As A Matter Of
16 Law ...........................................................................................11
17 6. The Undisputed Evidence Establishes That
Countrywide’s Use Of the Terms Prime and
18 Nonprime Was Not Misleading ................................................12
19 B. Defendants Are Entitled To Summary Judgment Of The
SEC’s Claims Concerning The Held-For-Investment
20 Portfolio...............................................................................................13
21 C. Countrywide’s Extensive Disclosures Are Inconsistent
With Scienter.......................................................................................15
22
D. Rule 13a-14 Does Not Give Rise To A Cause Of Action ..................15
23
24
25
26
27
28
IRELL & MANELLA LLP JOINT REPLY MEMORANDUM OF POINTS AND
Professional Corporations MOTIONS FOR SUMMARY JUDGMENT
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1 TABLE OF AUTHORITIES
2 Page(s)
3 Cases
4 Archdiocese of Mil. Supporting Fund, Inc. v. Halliburton Co.,
597 F.3d 330 (5th Cir. 2010)......................................................................... 15
5
Ernst & Ernst v. Hochfelder,
6 425 U.S. 185 (1976) ...................................................................................... 12
7 In re Countrywide Fin. Corp. Sec. Litig.,
588 F. Supp. 2d 1132 (C.D. Cal. 2008)......................................................... 11
8
In re Cutera Sec. Litig.,
9 610 F.3d 1103 (9th Cir. 2010)....................................................................... 10
10 In re Dynex Cap., Inc. Sec. Litig.,
2009 WL 3380621 (S.D.N.Y. Oct. 19, 2009) ............................................... 11
11
In re Worlds of Wonder Sec. Litig.,
12 35 F.3d 1407 (9th Cir. 1994)........................................................................... 8
13 Morrison v. Nat’l Australia Bank Ltd.,
130 S. Ct. 2869 (2010) .................................................................................. 12
14
SEC v. Black,
15 2008 WL 4394891 (N.D. Ill. Sept. 24, 2008) ............................................... 15
16 SEC v. Nacchio,
__ F. Supp. 2d __, 2010 WL 1380382 (D. Colo. Mar. 31, 2010) ................... 4
17
Varig Airlines v. Walter Kidde & Co., Inc.,
18 690 F.2d 1235 (9th Cir. 1982).............................................................4, 13, 14
19 Statutes
20 15 U.S.C. § 77q(a) ................................................................................................... 12
21 15 U.S.C. § 78j(b).................................................................................................... 12
22 Regulations
23 17 C.F.R. § 229.303...........................................................................................11, 12
24 17 C.F.R. § 229.1100 et seq....................................................................................... 4
25 17 C.F.R. § 240.10b-5 ............................................................................................. 12
26 17 C.F.R. § 240.13a-14............................................................................................ 15
27
28
Professional Corporations MOTIONS FOR SUMMARY JUDGMENT
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1 I. INTRODUCTION
2 The SEC’s assertion that discovery has made its case stronger is wishful
3 thinking. The undisputed facts and admissions in the record demolish the SEC’s
4 claims that Countrywide deceived stockholders about its originate-to-distribute
5 business and about its portfolio of pay-option loans. These points are not “straw
6 men” (Opp. at 1), but rather the core theories of the Complaint the SEC filed
7 following an extensive formal investigation that was more than sufficient to allow it
8 to plead its best case.
9 The SEC mistakenly argues that special rules apply in the cases it brings that
10 allow for fraud liability even when allegedly omitted facts are publicly available,
11 considered by stockholders and reflected in the company’s stock price. Id. at 17-19.
12 And although Countrywide stock traded in an efficient market, the SEC argues that
13 this case should survive summary judgment based on its unsupported speculation
14 that the Company’s stockholders – 93% of whom were sophisticated institutions –
15 were incapable of evaluating disclosed facts. Id. at 24-25. These novel ideas find
16 no support in the law – and if accepted would leave public companies in America
17 with no means of satisfying their disclosure obligations. Its repeated claims to
18 special status notwithstanding, even the SEC does not have the power to contort the
19 law simply to suit its needs in a particular case. Application of controlling legal
20 principles to the undisputed facts here compels summary judgment.
21 II. ARGUMENT
22 A. Defendants Are Entitled To Summary Judgment Of The SEC’s Claims
23 Concerning Countrywide’s Originate-To-Distribute Business
24 1. There Is No Triable Issue Of Fact About Whether Countrywide
25 Stockholders Knew About Guideline Expansion
26 The Commission concedes that Countrywide told investors that underwriting
27 guidelines for non-GSE loans “have been designed so that these loans are salable in
28 the secondary mortgage market.” UF 4. Indeed, the SEC now affirmatively argues
A Registered Limited Liability AUTHORITIES IN SUPPORT OF DEFENDANTS’
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1 that salability in the secondary market was an important driver of guideline changes.
2 Opp. at 3:8-10; 4:25-28; 23:2-3. And while the Complaint alleges that Countrywide
3 “misled investors by failing to disclose . . . the company’s pursuit of a ‘matching
4 strategy’” (Cmplt. ¶ 8), the SEC has completely reversed course, arguing now that
5 defendants actually “heralded [the matching strategy] to investors.” Opp. at 4; UF
6 6. Furthermore, the SEC finally admits what has been the elephant in the room
7 since this case was filed – i.e., that the “mortgage industry’s evolution towards more
8 lenient credit standards was well known and widely discussed in the popular press.”
1
9 UF 8; see also UF 6, 7, 73.
10 These admissions, together with the mountain of publicly available
11 information about Countrywide loans, refute the allegation that defendants “hid
12 from investors” that Countrywide “engaged in an unprecedented expansion of its
13 underwriting guidelines from 2005 and into 2007.” Cmplt. ¶ 4. As detailed in the
14 moving papers, these disclosures took different forms, including periodic reports on
15 Form 10-K and Form 10-Q, monthly 8-K filings, prospectus supplements for sales
16 of mortgage backed securities, free company websites and discussions with
17 investors in conference calls and other forums. Mem. at 8-11. Confronted with
18 these disclosures, the SEC does not defend its allegation that guideline expansion
19 was hidden, but instead tries to distance itself from its own Complaint. Opp. at 2
20 (“the SEC’s allegations are not merely about ‘widened underwriting guidelines’”).
21 But the record does not end with the disclosures themselves: It further
22 establishes that stockholders took the disclosures into account in setting the
23 Company’s stock price. The SEC admitted in response to an interrogatory that the
24 information about loan attributes and underwriting guidelines disclosed in the
25 prospectus supplements was reflected in the price. UF 48. Further, the SEC’s
26
1
That the industry-wide evolution towards more lenient credit standards was
27 well known also refutes any suggestion that Countrywide misled investors into
28 See Opp. at 3;its13:3-9.
thinking that underwriting guidelines were static and did not evolve over time.
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1 economist opines that “all publicly available information, including material

2 information . . . concerning Countrywide’s activities in mortgage and mortgage
3 securitization markets, was quickly and fully incorporated into the market price of
4 Countrywide’s stock.” UF 49. And the SEC also admits that information on
5 Countrywide’s websites – which includes comprehensive data about the credit
6 attributes of sold loans – was incorporated into its stock price. UF 52. These
7 admissions leave nothing to the SEC’s charge that Countrywide concealed from
8 stockholders the kinds of loans the Company sold into the secondary market.
9 The SEC has no effective response to these points. Its first argument, that
10 defendants are confusing “materiality” with “loss causation” (Opp. at 17), is wrong.
11 Last year, the SEC defended its allegation that defendants “hid” guideline expansion
12 by telling this Court that the disclosed information about loan attributes was not
13 “readily available to purchasers of Countrywide’s equity securities.” Dkt. No. 57 at
14 19. The Court relied on this argument in denying defendants’ motions to dismiss.
15 Order at 12. During discovery, defendants established that the loan attribute
16 information was reflected in the Company’s stock price not to prove absence of
17 “loss causation,” but to rebut the argument that it was not available to investors.
18 The fact that this information was reflected in the stock price shows not only that it
19 was available, but also that it was actually considered and used. Despite the SEC’s
20 admissions – and the opinions of its expert – it nevertheless persists in asserting that
21 loan attribute information was somehow not reasonably available. Opp. at 19:9-11;
22 22:22-23; 23:25-24:18. Nonsense. The SEC cites no case holding that information
23 actually reflected in a company’s stock price was not reasonably available to
24 stockholders, nor does it offer any logical explanation of how this could be so. The
25 SEC’s position here is inconsistent with the rationale underlying the very disclosure
26 regime that it has created and that it is supposed to enforce. UF 51 (purpose for
27 requiring EDGAR filings is to make information available to investors).
28
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1 Second, the SEC mistakenly claims that defendants are asserting a “truth on
2 the market” defense that the SEC argues does not apply in actions it brings. Opp. at
3 18. Although the proof that loan attribute information was reflected in
4 Countrywide’s stock price does refute the particular theory that the Company “hid”
5 guideline expansion from investors, defendants are not arguing that it constitutes a
6 complete defense to all of the SEC’s claims. Instead, the point is that information in
7 the stock price was part of the “total mix” of information that must be considered
8 when evaluating the SEC’s other falsity theories. That being said, the implications
9 of the SEC’s argument that the “truth on the market” defense does not apply to it are
10 astounding. Does the Commission really believe that public disclosure of the truth
11 and incorporation of the truth into a company’s stock price constitutes a defense
12 only in a private securities litigation and not in an SEC case? That absurd
13 proposition finds no support in the securities statutes or in the judicial authorities
14 construing them. See, e.g., SEC v. Nacchio, __ F. Supp. 2d __, 2010 WL 1380382,
15 at *17-18 (D. Colo. Mar. 31, 2010) (entering summary judgment against SEC
16 because the information in question was “already known to the public”).
17 Third, the SEC proffers a lengthy exegesis to the effect that the Company
18 confused stockholders by disclosing too much information. Opp. at 24-25. This is
19 an odd charge coming from the SEC, whose own regulations (17 C.F.R. § 229.1100
20 et seq.) prescribed the prospectus supplement disclosures. Mem. at 9. In any event,
21 this argument directly contradicts both the allegation that Countrywide “hid”
22 guideline expansion from investors and the SEC’s admission (and the opinion of its
23 expert) that the information was reflected in the stock price. Moreover, the notion
24 that Countrywide stockholders – 93% of whom were sophistication institutional
25 investors (Lefler Decl. Ex. 60 at 744) – could not understand disclosed information
26 is pure speculation, unsupported by any evidence. Therefore, it is insufficient as a
27 matter of law to create an issue of fact for trial. See, e.g., Varig Airlines v. Walter
28 Kidde & Co., Inc., 690 F.2d 1235, 1238 (9th Cir. 1982) (“a party cannot
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1 manufacture a genuine issue of material fact merely by making assertions in its legal
2 memoranda”).
3 Finally, the SEC accuses defendants of “sleight of hand” (Opp. at 1) in
4 arguing that the prospectus supplement and website disclosures communicated to
5 stockholders the facts about sold loans. The SEC’s own admission that the loan
6 attribute information was reflected in the Company’s stock price, however, refutes
7 this accusation. Ironically, it is the SEC that relies on deception. The Commission
8 argues without citation to any evidence that “Countrywide’s periodic filings
9 trumpeted that Countrywide was a primarily prime lender with ‘prudent’
10 underwriting guidelines.” Opp. at 20. In fact, it is undisputed that Countrywide told
11 stockholders that guidelines for loans sold through its originate-to-distribute
12 business were designed to satisfy the appetites of secondary market investors. UF 4.
13 In short, there is no genuine issue for trial concerning the allegation that
14 defendants “hid from investors” the expansion of underwriting guidelines.
15 2. There Is No Triable Issue About Whether The Alleged
16 Omissions Concerning Exception Loans And Quality Control
17 Audits Were Misleading Or Material
18 Confronted with evidence refuting the Complaint’s theory that Countrywide
19 concealed guideline expansion, the SEC shifts focus in the Opposition arguing that
20 the Company omitted facts about so-called “exception” loans and about the results
21 of quality control audits. Opp. at 4-7. These arguments are unavailing.
22 The SEC’s arguments about exception loans do not give rise to any genuine
23 issue of fact as to whether Countrywide materially misled stockholders. As an
24 initial matter, the SEC simply distorts what an exception loan is, implying that the
25 exceptions process represented an abdication of any “prudent” underwriting
26 practices. The SEC’s own evidence, however, shows that an exception loan is
27 simply one that did not qualify for automatic approval under the Company’s
28 proprietary computerized underwriting systems and thus required review by a
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1 human underwriter. SF 280. As the SEC’s own evidence also reveals,

2 Countrywide’s human underwriters had authority to approve loans referred out by
3 the Company’s automated systems. McCoy Decl. Ex. 271 at 1134-35. The SEC
4 mistakenly argues that the use of exception loans misled stockholders because
5 exceptions made to pre-approved guidelines were driven by secondary market
6 considerations. Opp. at 30 (Countrywide’s practice was to “writ[e] any loan that it
7 could sell into the secondary market, whether or not that loan met Countrywide’s
2
8 underwriting guidelines”). This argument is wrong, however, because
9 Countrywide expressly disclosed that its credit policy was designed to meet
10 secondary market standards. UF 4. Thus, the SEC presents no genuine question of
11 fact as to how Countrywide’s exception loan processes were at all inconsistent with
12 stockholder expectations. Additionally, it is undisputed that Countrywide disclosed
13 the credit risk attributes of the loans it sold into the secondary market, and the SEC
14 has offered no explanation why Countrywide stockholders would even care whether
15 those loans were approved by automated systems or by human underwriters. And
16 while the SEC argues that exception loans were more likely to default than
17 computer underwritten loans (Opp. at 5), it has shown no evidence that this ever
18 interfered with Countrywide’s ability to sell them.
19 The SEC also completely ignores Countrywide’s routine disclosure of its use
20 of exception underwriting. Mem. at 20. It is undisputed that at least 82 of the
21 prospectus supplements disclosed that a “significant number” of the mortgages in
22 the described pool were originated as exceptions. UF 53. Thus, the argument that
23 2
While the details about Countrywide’s exception processes are not important
24 to the outcome of this motion, the SEC’s pejorative description of those processes
misstates the very evidence it cites. For example, the SEC erroneously asserts that if
25 a loan was referred to Countrywide’s Secondary Markets Structured Lending Desk,
“no attempt was made to underwrite the loan at all, and the sole criterion for
26 approving the loan was whether Secondary Marketing could sell the loan.” Opp. at
4. The document the SEC cites for this “fact,” however, states that, when approving
27 an exception, SLD will “be relying on Production to make certain that the loan
meet[s] all other underwriting Guideline [sic] and w[i]ll have been reviewed for
28 compliance acceptability and fraud.” Defendants’ Response to SF 282. Similar
problems abound in the SEC’s purported facts. See id. SF 299, 469, 558.
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1 the use of exceptions – even the significant use of exceptions – was “omitted” is
2 meritless.
3 The SEC’s arguments about quality control audits suffer from similar flaws.
4 The SEC has adduced no evidence that stockholders ever expressed any interest
5 whatsoever in the results of quality control audits for sold loans. Moreover, the SEC
6 cites no evidence indicating that Countrywide’s ability to sell mortgages into the
7 secondary market – or any other aspect of its originate-to-distribute business – was
3
8 ever adversely affected by the results of quality control audits.
9 The SEC’s sole argument that exception loans and quality control audits were
10 material is that Countrywide’s stock price declined by 11% on July 24, 2007, when
11 it announced second quarter financial results and again on August 16, 2007, when it
12 drew down its backup credit lines. Opp. 20-21. The SEC, however, cites no
13 evidence that Countrywide disclosed any information – let alone new information –
14 about exception loans or quality control audits on either of these dates; there is no
15 reference to these matters in the cited disclosures. Id. Thus, these price declines do
16 not establish that exceptions and quality control audits mattered to stockholders.
17 3. The SEC Has Come Forward With No Evidence That
18 Undisclosed Loan Quality Problems Disrupted The Originate-
19 To-Distribute Business
20 The SEC charges defendants with failing to disclose that the “deteriorating
21 quality” of Countrywide loans “would ultimately curtail the company’s ability to
22 sell those loans in the secondary mortgage market.” Cmplt. ¶ 5. This is a critical
23 element of the SEC’s case because without it the SEC has no theory for why the
4
24 credit quality of sold loans was material to stockholders. Contrary to the SEC’s
25 3
The SEC points out that in one instance in early 2006 HSBC “put back” a
number of subprime second lien mortgages that it had purchased from Countrywide.
26 Opp. at 26-27; SF 309. This “put back,” however, was not the result of a
Countrywide quality control audit, and there is no dispute that Countrywide properly
27 accounted for this transaction.
4
28 The SEC correctly points out that Countrywide retained some credit risk
even for sold loans. Opp. at 8. The Complaint, however, does not allege, nor does
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1 claim, the evidence shows that the entire secondary market shut down in the second
2 half of 2007 – a point acknowledged by the SEC’s own expert. Mem. at 12-13.
3 Defendants’ showing shifted the burden to the SEC to come forward with
4 substantial evidence that undisclosed loan quality problems curtailed Countrywide’s
5 ability to sell loans. Mem. at 22.
6 Unable to meet this burden, the SEC disclaims it. Ignoring the Complaint’s
7 allegations (which it wrongly accuses defendants of misunderstanding (Opp. at 25)),
8 the SEC argues merely that Countrywide management recognized that secondary
9 market demand for relatively risky mortgage products might someday wane. Id. at
10 26-27. Countrywide, however, disclosed its dependence on the secondary market, a
11 fact acknowledged in the Complaint: “Countrywide was more dependent than many
12 of its competitors on selling loans it originated into the secondary mortgage market,
13 an important fact it disclosed to investors.” Cmplt. ¶ 5. Not only did Countrywide
14 disclose this risk, but securities analysts wrote about the possibility that investor
15 demand for relatively risky mortgage products might change. Mem. at 5-6. This
16 possibility was not a secret, but rather a fundamental and structural business risk
17 inherent in the originate-to-distribute model. The materialization of that risk is
18 simply not fraud. In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1420 (9th Cir.
19 1994) (adopting district court’s analysis that “[t]he securities laws do not . . .
20 provide insurance against risks that were disclosed to investors”) (citation omitted).
21 When it filed this lawsuit, the SEC understood that. Accordingly, it fashioned
22 the theory that Countrywide’s ability to sell loans was “curtailed” not by market
23 forces affecting the entire industry, but by Countrywide-specific loan quality
24 problems that were supposedly a secret. Cmplt. ¶ 5. This allegation was, and
25 remains, fiction: The secondary market evaporated for reasons having nothing to do
26
27
28 the Commission otherwise argue, that Countrywide misled investors about these
retained risks or the accounting for them. See Mem. at 5 n.4.
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1 with supposed loan quality problems unique to Countrywide. The SEC – which
2 bears the burden on this issue – has come forward with no proof otherwise.
3 Unable to prove its allegations about why Countrywide became unable to sell
4 loans, the SEC argues alternatively that the Company’s stock price decline on July
5 24, 2007, somehow establishes that the credit risks of sold loans were material.
6 Opp. at 27. This simply does not follow, however, because the SEC argues
7 (incorrectly, as discussed below) that the July 24 decline resulted from allegedly
8 new information about the pay-option portfolio held at the Bank, not from
5
9 disclosures of new information about the credit attributes of sold loans. Id.
10 In short, the SEC has no evidence supporting its allegation that
11 Countrywide’s access to the secondary market was “curtailed” by undisclosed loan
12 quality problems. This, by itself, warrants summary adjudication.
13 There is no genuine issue for trial about whether Countrywide misled
14 stockholders about its originate-to-distribute business – under either the initial
15 theory alleged in the Complaint or the new theory argued in the Opposition. The
16 SEC’s rhetoric makes plain that – with the luxury of hindsight – the Commission
17 disapproves of the riskier mortgage products that were popular with consumers and
18 secondary mortgage market investors between 2005 and 2007. The undisputed
19
5
The SEC argues that defendants cannot explain why Countrywide’s share
20 price declined by 11% on July 24. Opp. at 27. This argument is misguided because
the SEC bears the burden of proving materiality, not the reverse. Nevertheless, the
21 reasons for Countrywide’s price decline (while irrelevant to the outcome of this
motion) are straightforward and plainly the result of factors unrelated to the SEC’s
22 claims. In dollar terms, Countrywide declined by $3.56 on July 24. Before the
23 second quarter profits and reducing its press
market opened, the Company issued a release announcing disappointing
earnings projections for the balance of 2007
24 based on difficult market conditions, including specifically the housing market. See
http://www.sec.gov/Archives/edgar/data/25191/000110465907055537/a07-
25 20103_1ex99.htm. In response to these disclosures, Countrywide’s stock price
declined by $2.79 at the opening of the day, hours before the conference call to
26 which the SEC refers. Lefler Decl. Ex. 191 at 2474. Additionally, as discussed
infra at II.B., the comments about pay-option loans on the conference call could not
27 have moved Countrywide’s stock price because they were disclosed previously. If
anything said on the call moved the price, it was more likely Mozilo’s statement that
28 “[w]e are experiencing home price depreciation almost like never before, with the
exception of the Great Depression.” UF 104.
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1 evidence, however, establishes that Countrywide stockholders understood the

2 business in which they were investing. If investors then had disapproved of risky
3 mortgages they were free to sell their stock and invest elsewhere. The inconvenient
4 truth about the SEC’s case is that Countrywide’s business model was popular with
5 stockholders, not because it was misunderstood, but because it was profitable.
6 Mem. at 5.
7 4. The Challenged Statements About Loan Quality Are
8 Nonactionable Puffery
9 Shorn of the claim that Countrywide misled stockholders about the nature of
10 its originate-to-distribute business, the SEC’s case boils down to a handful of
11 affirmative statements – e.g., that Countrywide “manage[d] credit risk,” had
12 “quality” loans, or had “prudently underwritten” pay-option loans – that are too
13 vague as a matter of law to mislead investors. Opp. at 11-15.
14 The SEC’s argument on this issue loses sight of the key issue. As the Ninth
15 Circuit recently noted, statements are actionable under the securities laws when they
16 affect investors’ decisions in “valuing corporations.” In re Cutera Sec. Litig., 610
17 F.3d 1103, 1111 (9th Cir. 2010). In this case, the SEC argues that Countrywide’s
18 business strategy of underwriting loans to secondary market standards rendered
19 untrue its use of the terms “quality” and “manage[d] credit risk.” Opp. at 30. But it
20 is undisputed that Countrywide stockholders knew both the Company’s policy of
21 underwriting to secondary market standards and the attributes of the sold loans.
22 Under these circumstances, the terms “quality” and “manage[d] credit risk” could
6
23 not have misled investors as a matter of law. Similarly, Countrywide’s statement
24 6
Although not relevant to the outcome of this motion, these statements were
25 true. While the SEC tries to portray Countrywide as a company that disregarded
credit concerns, the evidence on which the SEC relies is, ironically, materials from
26 Countrywide committees tasked with addressing credit risk issues and emails
showing credit officers doing (not ignoring) their jobs. Many of these materials
27 were written by McMurray, the Company’s Chief Risk Officer, who is the star
witness of the Complaint, in which he is named 31 times. McMurray, however,
28 testified “both before I arrived at the company and then since then, my observation
and belief is that the manufacturing process, so the infrastructure, the people, the
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1 that it believed it had “prudently underwritten” the loans contained in the pay-option
2 portfolio could not have misled investors because the Company explained what it
3 meant by that statement – average FICO scores of approximately 718 and loan to
4 value ratios of approximately 78%. UF 37.
5 The SEC invokes Judge Pfaelzer’s decision in In re Countrywide Fin. Corp.
6 Sec. Litig., 588 F. Supp. 2d 1132 (C.D. Cal. 2008), but references only the outcome
7 and not the Court’s reasoning. Judge Pfaelzer wrote that “[i]t cannot be emphasized
8 enough that in the vast majority of cases [the] statements [at issue here] would be
9 nonactionable puffery.” Id. at 1153. She allowed the statements to survive a motion
10 to dismiss only because the plaintiffs alleged the “extraordinary case” where the
11 Company’s public statements about its loans were “so at odds” with the true facts
12 that shareholders might have been misled. Id. at 1144. This case is at summary
13 judgment, not at the pleading stage, and allegations must now give way to proof.
14 The record after discovery shows that Countrywide’s public statements were not “at
15 odds” with its business operations. It told stockholders that it originated mortgages
16 for sale, and it made voluminous disclosures about the attributes of its loans.
17 Therefore, under the reasoning of Judge Pfaelzer’s decision the challenged
7
18 statements are nonactionable puffery.
19 5. The Requirements Of Regulation S-K Item 303 Do Not Give
20 Rise To Fraud Liability As A Matter Of Law
21 The SEC accuses defendants of “willfully” misstating its position to be that
22 Item 303 sets the disclosure standard for fraud claims. Opp. at 30 & n.7. Yet that is
23 what the SEC argues in its brief, both in its heading stating that Item 303 “gives rise
24
processes, the systems [at Countrywide] were superior to what I had seen anywhere
25 else.” Priebe Decl. Ex. 290 at 18-19.
7
The SEC’s other authorities do not change this result. The case the
26 Commission spends the most time on, In re Dynex Cap., Inc. Sec. Litig., 2009 WL
3380621, at *8 (S.D.N.Y. Oct. 19, 2009), is an out of circuit pleading case. Opp. at
27 29. Pleading cases, such as Dynex and the other cases the SEC cites, are not
instructive here since
28 do not apply on summary plaintiffs are entitled to presumptions at the pleading stage that
judgment.
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1 to a duty to disclose” and in the body of its brief stating that if management
2 identifies a trend “[d]isclosure is then required [in the periodic filings] even if the
3 information is disclosed elsewhere.” Id. (emphasis in original). Accusations aside,
4 the SEC is expressly relying on Item 303 to set the standard of disclosure for its
5 securities fraud claims under Section 10(b) and Section 17(a).
6 This, however, is not the law. As explained by the numerous authorities cited
7 in defendants’ opening brief, an Item 303 violation does not establish a claim for
8 securities fraud because the standard of disclosure under Item 303 is more stringent
9 than that under the antifraud statutes. Joint Brief at 25-26 & n.14. The SEC all but
10 ignores these judicial authorities, arguing instead from its own interpretative
11 releases and administrative decisions that involve non-fraud “books and record”
12 statutes and regulations, not Section 10(b) and Section 17(a). These administrative
8
13 materials simply do not apply here.
14 6. The Undisputed Evidence Establishes That Countrywide’s Use
15 Of the Terms Prime and Nonprime Was Not Misleading
16 The record refutes the SEC’s allegations that Countrywide’s use of the terms
17 “prime” and “nonprime” was misleading. Mem. at 27-29. Indeed, the SEC’s expert
18 specifically admitted that the term “nonprime” was not misleading. Id. The points
19 elaborated in the moving papers need not be repeated here, since the SEC simply
20 ignores them in the single paragraph of its Opposition devoted to the
21 prime/nonprime issue. Opp. at 33. Suffice it to say that the SEC’s new argument
22 that Countrywide “asserted that prime and subprime loans were in fact distinct
23
8
24 deference The SEC’s argument that its interpretation of Item 303 is entitled to
(Opp. at 31-32 n.8) is irrelevant since Item 303 does not establish the rule
of decision.
25 liability beyondMoreover, the SEC cannot use its rulemaking authority to expand
the scope prescribed by Congress. See Ernst & Ernst v. Hochfelder,
425 U.S. 185, 213-14
26 agency charged with the (1976) (“The rulemaking power granted to an administrative
administration of a federal statute is not the power to make
27 case, its scope cannot exceed view
law. . . . [D]espite the broad of [Rule 10b-5] advanced by the [SEC] in this
the power granted the Commission by Congress under
28 §(SEC
10(b).”); Morrison v. Nat’l Australia Bank Ltd., 130 S. Ct. 2869, 2887-88 (2010)
interpretations conflicting with case law not entitled to deference).
2291027 - 12 -
#:18978
1 categories” (id.) is untrue. The SEC cites no evidence for this accusation, nor could
2 it. On the contrary, McMurray routinely presented a chart to investors showing that
3 the distinctions between prime and subprime loans were “blurring.” UF 59; Lefler
4 Decl. Ex. 76 at 1410 (McMurray stating to investors that the prime and subprime
5 categories “overlap more than they don’t overlap”). Moreover, the SEC cites no
6 actual evidence that Countrywide’s use of the admittedly imprecise (Mem. at 27)
7 terms “prime” and “nonprime” misled anyone. Instead, the Commission
8 impermissibly relies solely on its own assertions. Varig Airlines, 690 F.2d at 1238.
9 B. Defendants Are Entitled To Summary Judgment Of The SEC’s Claims
10 Concerning The Held-For-Investment Portfolio
11 Charged rhetoric (Opp. at 33-35) cannot obscure the fact that the SEC does
12 not challenge the accuracy of Countrywide’s extensive factual disclosures about the
13 attributes of its pay-option loans (UF 29-33, 36-47) or Countrywide’s accounting for
14 the pay-option portfolio, including particularly the allowance for loan losses.
15 Hairston Decl. Ex. 284 at 14-15.
16 Regarding Mozilo’s “flying blind” email – a centerpiece of the SEC’s media
17 campaign when it filed this lawsuit – the SEC never responds to the SRM court’s
18 reasoning. That court held that the concerns Mozilo expressed in the email do not
19 give rise to an actionable fraud claim because uncertainties about the performance of
20 Countrywide’s pay-option portfolio were in fact disclosed, both in the Company’s
21 SEC filings and by Mozilo personally in investor conference calls. Mem. at 30-32.
22 Sidestepping this point, the SEC argues that it “has more than a single email
23 evidencing Mozilo’s serious concerns.” Opp. at 35. That is no answer to the point
24 that the concerns expressed in the “flying blind” email – or the other emails for that
25 matter (Mem. at 33-35) – were disclosed. The SEC does not even argue that the
26 SRM court’s analysis was wrong. It merely points out that SRM was decided at the
27 pleading stage (Opp. at 35) – but this cuts against the SEC, since this case is at
28
2291027 - 13 -
#:18979
1 summary judgment, which unlike a pleading motion, requires the SEC to defend its
9
2 allegations with evidence.
3 Nor is the argument that Countrywide did not disclose the results of a 4506
4 Audit in mid-2006 sufficient to create a triable issue of fact. Opp. at 34, 36.
5 Countrywide told investors that “substantially all” of the pay-option loans in the
6 Bank’s portfolio were underwritten on a reduced documentation basis. Countrywide
7 told investors that reduced documentation loans were 1.5 to 3.5 times more likely to
8 go into delinquency than full documentation loans. And Countrywide properly
9 accounted for the risk of borrower fraud – a risk widely known and discussed in the
10 popular press (UF 73) – in establishing its unchallenged allowance for loan loss
11 reserves. Mem. at 33-35. The SEC ignores all of these points, and merely asserts
12 that the failure to disclose the results of this particular audit somehow misled
13 stockholders. Again, the SEC’s mere assertions are insufficient as a matter of law to
14 defeat summary judgment. Varig Airlines, 690 F.2d at 1238.
15 Finally, the SEC argues that Countrywide’s supposed omissions about the
16 pay-option portfolio were material because the Company’s stock price declined on
17 July 24, 2007. Opp. at 21, 27, 34. The SEC wrongly asserts that July 24 was the
18 first time Countrywide told investors (a) that most pay-options were reduced
19 documentation loans (Opp. at 21), and (b) that the Bank’s held-for-investment
20 portfolio “included loans with subprime FICOs [sic] scores.” Opp. at 34. In fact,
21 Countrywide disclosed in its periodic filings in 2006 – the year before the
22 conference call – that “substantially all” of its pay-option loans were issued on
23 reduced borrower documentation. UF 70. Similarly, Countrywide disclosed the
24 range of FICO scores of its held-for-investment portfolio in its 2006 Report on Form
25 9
Regarding the May 2006 Sanford Bernstein conference, the SEC does not
26 untrue. UFMozilo’s
argue that statements about the history of the pay-option product were
34-35. Instead, the SEC argues that Mozilo personally did not take
27 comfort from that history in assessing the risks of Countrywide’s pay-option
portfolio. Opp. at 36. This is hardly significant in light of Mozilo’s direct
28 statements to investors about his concerns regarding the performance of the
portfolio. Mem. at 31-32; UF 66-67.
2291027 - 14 -
#:18980
1 10-K. See Lefler Decl. Ex. 4 at 138 (showing $3.4 billion in HFI loans with FICO
2 scores below 660 and $159 million with FICO scores below 620). Mozilo also
3 personally disclosed similar information at the May 2006 Sanford Bernstein
4 conference. Dean Decl. Ex. 170 at 4378 (“16% of pay option loans produced for
5 our bank have FICO scores below 680 and only 3% below 660”). Thus,
6 Countrywide’s price decline on July 24 cannot be explained by either of these
10
7 facts. Archdiocese of Mil. Supporting Fund, Inc. v. Halliburton Co., 597 F.3d 330,
8 337 (5th Cir. 2010) (“[c]onfirmatory information is already known to the market
9 and, having been previously digested by the market, will not affect the stock price”).
10 C. Countrywide’s Extensive Disclosures Are Inconsistent With Scienter
11 Executives intent on misleading investors do not make the comprehensive
12 disclosures that Countrywide made about both its originate-to-distribute business
13 and about its pay-option portfolio. Even if one were to conclude that certain of
14 Countrywide’s disclosures should have been made in a different place or in slightly
15 different words – which, in the end, is the gravamen of the SEC’s case – that is
16 insufficient to give rise to a claim of intentional fraud. The SEC’s argument
17 regarding scienter (Opp. at 36-38) does nothing to refute this common sense point.
18 D. Rule 13a-14 Does Not Give Rise To A Cause Of Action
19 The SEC argues that Rule 13a-14 creates an independent cause of action
20 based on the same two cases it cited previously. In SEC v. Black, 2008 WL
21 4394891 (N.D. Ill. Sept. 24, 2008), however, the court directly addressed both of
22 these cases, correctly holding that “neither [of them] addresses whether a false
23 certification can stand as an independent claim.” Id. at *16. Indeed, when Rule
24 13a-14 was first proposed, the SEC indicated that no separate cause of action exists.
25 See id. (quoting SEC Release No. 8124, 2002 WL 3170215, at *9 (Aug. 28, 2002)).
26 10
The sole basis for the SEC’s erroneous claim that July 24 was the first time
27 SF 469-71.ofThe
that either these facts was disclosed is the testimony of a single equity analyst.
mere fact that this one analyst missed or forgot these disclosures –
which he admitted in his testimony (Defendants’ Response to SF 469) – does not
28 create a genuine issue for trial.
2291027 - 15 -
#:18981
1 Dated: August 23, 2010 IRELL & MANELLA LLP

2 WILLIAMS & CONNOLLY LLP
3
4 By: /s/ David Siegel
David Siegel
5 dsiegel@irell.com
1800 Avenue of the Stars, Suite 900
6 Los Angeles, California 90067
Telephone: 310-277-1010
7 Facsimile: 310-203-7199
8 Attorneys for Defendant Angelo Mozilo
9
10 Dated: August 23, 2010 ORRICK, HERRINGTON & SUTCLIFFE
LLP
11
12
By: /s/ Walter F. Brown, Jr.
13 Walter F. Brown, Jr.
wbrown@orrick.com
14 The Orrick Building
405 Howard Street
15 San Francisco, California 94105
Telephone: 415-773-5700
16 Facsimile: 415-773-5759
17 Attorneys for Defendant David Sambol
18
19 Dated: August 23, 2010 DLA PIPER LLP (US)
20
21 By: /s/ Shirli Fabbri Weiss
Shirli Fabbri Weiss
22 shirli.weiss@dlapiper.com
401 B Street, Suite 1700
23 San Diego, CA 92101-4297
Telephone: 619-699-2700
24 Facsimile: 619-699-2701
25 Attorneys for Defendant Eric Sieracki
26
27
28
2291027 - 16 -

Mozilo's Response in Support of The Motion To Dismiss

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Mozilo's Response in Support of The Motion To Dismiss

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Case 2:09-cv-03994-JFW-MAN Document 321 Filed 08/23/10 Page 1 of 19 Page ID

1 IRELL & MANELLA LLP

1 economist opines that “all publicly available information, including material

1 human underwriter. SF 280. As the SEC’s own evidence also reveals,

1 evidence, however, establishes that Countrywide stockholders understood the

1 Dated: August 23, 2010 IRELL & MANELLA LLP

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