Malaysia's ministry of internal affairs seized the Swatch watches during raids on May 13 and 14, it said.
The ministry did not immediately respond to a request for comment.
The watches belong to the Swiss watchmaker's "Pride collection" which it says was created to celebrate the pride movement and its message of equality and diversity.
Chief Executive Nick Hayek said he was disappointed and concerned.
"We strongly contest that our collection of watches using rainbow colours and having a message of peace and love could be harmful for whomever," he said in a statement to Reuters.
The rainbow flag is a symbol of the LGBT movement, which supports the rights of lesbian, gay, bisexual, transgender and intersex people.
The company said it would take legal action to recover the goods, Swiss newspaper Tages-Anzeiger reported.
Human rights groups and activists have raised concerns over Malaysia's growing intolerance towards the lesbian, gay, LGBT community in recent years.
Last year, the country's Islamic religious authorities questioned 18 people detained during a Halloween party attended by members of the LGBT community.
Same-sex acts are illegal in Malaysia, although convictions are rare. The country has a dual-track legal system, with Islamic criminal and family laws applicable to Muslims running alongside civil laws.
(Reporting by John Revill, Additional reporting by Rozanna Latiff in Kuala Lumpur; Editing by Raju Gopalakrishnan)
