Risk Management

Is the Brocade CEO’s Backdating Trial Unraveling?

The judge in the case against former CEO Greg Reyes expects to rule July 19 about whether he will grant a defense motion to dismiss. A question is ...
Roy HarrisJuly 10, 2007

The federal judge in the government’s first stock-options backdating criminal case — against Brocade Communications Systems ex-CEO Greg Reyes — said he would rule next Thursday on whether to grant a defense motion to end the trial without sending it to the jury.

Prosecutors finished their case late last week without calling former Brocade CFO Michael J. Byrd to testify. He had been on the government’s list, and some observers had expected him to be a star witness, according to the San Jose Mercury News. No explanation was given for the government’s decision not to call Byrd.

The government’s initial trial stemming from the two-year nation-wide backdating scandal has been a puzzle to legal experts who have watched to see what a Brocade outcome could mean for the numerous other potential cases. Federal investigators have targeted more than 140 companies, even though cases have been brought at only six companies so far, naming 10 executives, according to the Wall Street Journal.

Speculation on the state of mind of U.S. District Court Judge Charles Breyer — brother of U.S. Supreme Court Justice Stephen Bryer — has swung in the direction of both the defense and the prosecution over the trial’s three weeks. Those who see Judge Breyer as likely to grant the defense motion to dismiss the case on July 19, without letting it go to the jury, argue that he has at times seemed unconvinced that the government’s case showed Reyes’ knowledge that what he was doing was improper or illegal.

The judge last week asked the prosecution to answer all his questions in writing over the weekend, although he allowed the defense case to continue in front of the jury. The Reyes defense is expected to take at least a week. Legal authorities have suggested in media accounts that it is unusual for such a defense motion to be granted during a trial that is being heard by a jury.

Other observers have noted that, unlike in other corporate backdating cases, the CEO did not grant himself any backdated stock options at the San Jose-based network switch-maker. These court-watchers suggest that this factor may weaken the government’s characterization of Reyes as someone who misled investors and regulators in a conspiracy to defraud in Brocade’s 2000-to-2004 financial statements.

Assistant U.S. attorney Tim Crudo, however, has argued that the government needs only show “that he knew what he was doing was wrong,” according to the Mercury News, and Crudo believes that enough of a case has been made in that regard.

In his opening remarks , the prosecutor had told the jury
that the case “is about deception, it’s about lies, and it’s about fraud,” and he had noted that backdated options grants all bore Reyes’ signature. News outlets had reported that Byrd, a former Ernst & Young partner, had been granted immunity by prosecutors.

In the opening statement for the defense, attorney Richard Marmaro told the jury that Brocade’s history of granting stock options “begins with Mike Byrd,” who Marmaro said had “conceived and approved” the backdating practices.

The defense has not contested that backdating occurred on Reyes’ watch, but has said that the CEO did not know it was illegal, and that it was done so that Brocade’s incentives would attract employees to the software company.

According to press reports of the trial, however, the most dramatic illustration by the prosecution that Reyes knew he had acted illegally was testimony by former Brocade human-resources employee June Weaver, who said the CEO had told her: “It’s not illegal if you don’t get caught.” Under cross-examination, however, she said she could not specify exactly what “it” was, although she felt sure the topic was stock-option grants.

In May, the Securities and Exchange Commission settled civil fraud charges
for $7 million with Brocade, which did not admit to or deny the SEC’s backdating allegations.