"Hundreds should go to jail," wrote Motley Fool co-founder Tom Gardner earlier this year, referring to the culprits behind our financial meltdown. And while jail might not be in the cards just yet, we're finally on the right track.

The SEC has filed a civil fraud suit against former Countrywide CEO and international tanning sensation Angelo Mozilo, as well as two other former executives. Insider trading charges may also be on the table for Mozilo. Countrywide, you'll remember, sold itself to Bank of America (NYSE:BAC) early last year.

The suit basically claims that from 2005-2007, Countrywide underwrote mortgages to anyone with a heartbeat and smile, while leading investors to believe it was a conservative lender. This might seem rather subjective at first, but the SEC backed its case with some fairly evident confessions, including an internal email sent by Mozilo regarding so-called 80/20 loans, which let subprime borrowers take out two mortgages on the same house. The message states:

In all my years in the business I have never seen a more toxic [product.] It's not only subordinated to the first [mortgage], but the first [mortgage] is subprime. In addition, the FICOs are below 600, below 500 and some below 400[.] With real estate values coming down ... the product will become increasingly worse.

Good luck defending that one.

In response to realizing how shoddy its lending practices were, Countrywide's enterprise risk assessment officer sent a memo to Mozilo, stating in part:

  • "Borrower repayment capacity was not adequately assessed by the bank during the underwriting process ..."
  • "Debt-to-income (DTI) ratios did not consider the impact of principal [negative] amortization or an increase in interest."

Translation: "Not only are we loaning money to people who probably can't pay us back, but what scant math we use to assess their credit worthiness is completely flawed."

In short, it's abundantly clear to me that Mozilo and other senior executives knew their business was about to blow up. Yet they essentially did nothing about it. More importantly -- and here's where the fraud allegation comes in -- they didn't disclose the information to shareholders.

OK, actually, they did do something about it. Knowing the game was up, Mozilo allegedly sold $140 million worth of stock during this period. This could constitute insider trading, because the emails and memos show that he knew material information about the company's deterioration that wasn't revealed to shareholders. Go on. Take the money and run.

What's this all mean for the industry? With any luck, the suit against Mozilo will spark a broader trend of holding CEOs accountable. Can the SEC find similar cases of criminality at Washington Mutual? Wachovia (now part of Wells Fargo (NYSE:WFC))? Bear Stearns (now part of JPMorgan Chase (NYSE:JPM))? Lehman Brothers? AIG (NYSE:AIG)? Merrill Lynch? Fannie? Freddie? While I don't know of any evidence, I wouldn't be shocked.

Stupidity isn't a crime. Concealing your stupidity when you have a duty to your shareholders is. And anyone who did so should pay for it.

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