Risk Management

Brocade’s Reyes Guilty of Backdating

The U.S. government wins its first time out in a case targeting the misdating of stock options by a CEO.
Stephen TaubAugust 7, 2007

A federal jury convicted former Brocade Communications Systems CEO Gregory Reyes on all 10 felony counts, giving the federal government an opening victory in its war against executives implicated in schemes to backdate stock-option grants.

The verdict, in the Justice Department’s first case to reach trial, could open a floodgate of criminal charges against other executives at companies where stock-option backdating has been identified. Currently, the government has brought criminal charges against at least 10 executives, according to the Associated Press.

The government reportedly has been considering the filing of criminal charges against former executives at a number of other companies, AP said, including Apple Inc., KLA-Tencor Corp., and Broadcom Corp. All these companies have admitted to transgressions of some sort related to their dating of stock-option grants.

Reyes was charged last July with 12 felony counts of securities fraud and other offenses, although the two mail-fraud charges were subsequently dropped. The trial went through a roller coaster of apparent strategy shifts. At first, with Brocade ex-CFO Michael J. Byrd listed as a potential government witness, it was suggested that Byrd might be a star witness,
for example. But he was never called by prosecutors. Near the end of the trial, District Judge Charles Breyer, brother of U.S. Supreme Court Justice Stephen Breyer, shocked some observers by considering a defense motion to end the trial without sending it to the jury.

But yesterday, Reyes was convicted of all charges after six days of jury deliberations, according to Bloomberg. He faces as much as 20 years in prison for the most serious charges, and millions of dollars in fines. Sentencing is scheduled for Nov. 21. He still faces civil charges by the Securities and Exchange Commission, as well.

Reyes was fired in January 2005 from San Jose, Calif.-based Brocade, the world’s largest maker of switches for data-storage networks.

Asked by reporters for his reaction, defense attorney Richard Marmaro said, “Total shock.” AP noted that Reyes wiped his forehead with a handkerchief and glared at the jury as the verdict was announced. His wife cried.

Prosecutors argued that Reyes intentionally misled shareholders between 2000 and 2004 by a “systematic practice of cherry-picking low stock prices” through the backdating of grants and then improperly accounting for them, according to Bloomberg News. The practice made Brocade appear more profitable than it was, the government argued.

According to Dow Jones, the prosecution had maintained that Reyes engaged in a conspiracy with Stephanie Jensen, Brocade’s former head of human resources, to backdate options as a recruiting technique. Then, meeting minutes were repeatedly falsified to hid the practice from accountants.

Reyes’s attorney, Marmaro, stressed that he had no accounting background, and thus relied on the company’s finance department to oversee accounting for stock option grants. Marmaro at one point argued that Brocade’s history of misdated stock-option grants “begins with Mike Byrd,” the former Ernst & Young partner who had “conceived and approved” the practices at Brocade, according to the attorney.

Defense attorneys also asserted that stock option expenses did not affect Brocade’s cash reserves.

Government attention to the national scandal over backdating has led it to target more than 140 companies for inestigation, although so far only the 10 executives have been charged.