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Cloud Call Center Community Featured Article

[June 18, 2007]

Lawyers in Brocade stock options backdating trial say intent will be central issue

By JORDAN ROBERTSON AP Technology Writer
The Associated Press

Gregory Reyes, the former chief executive of Brocade (News - Alert) Communications Systems Inc., either masterminded a stock options backdating scheme designed to defraud investors -- or fell victim to murky accounting laws and heightened public scrutiny to corporate accounting errors, lawyers said Monday.

The criminal trial against Reyes, charged with 10 felony counts of securities fraud and other offenses, began Monday in a packed federal courtroom with observers spilling out into the hallway and into a nearby courtroom where they listened to an audio feed.

Reyes' case is the first to go to trial alleging criminal offenses connected to suspect timing of stock option awards. The Securities and Exchange Commission has investigated more than 100 companies over so-called backdating.

The practice refers to reaching back to a date when the company's stock price was at a low, and selecting that date for the option grant's exercise price, or the price an employee will pay for the stock. The goal is to boost the potential windfall for the recipient.

Reyes is accused of falsifying board of directors meeting records, signing off on false financial statements, and lying to the company's financial auditors and investors to hide that the company should have been paying compensation expenses for options grants that already had value at the time they were awarded.

In delivering their opening statements, Assistant U.S. Attorney Tim Crudo and Reyes' defense lawyer, Richard Marmaro, each highlighted what will be a central issue of the trial -- the allegation of criminal intent.

Jurors will decide whether Reyes intentionally concealed information about the company's options grants to avoid paying hefty compensation expenses and boost the bottom line, as Crudo argued. Or they may determine that Reyes believed the financial statements accurately accounted for the grants, as Marmaro argued.

"This scheme was not a mistake," Crudo said during his half-hour opening statement, using a PowerPoint presentation with calendars marked in red and green to highlight the days options were granted versus when the company recorded them. "Every time Mr. Reyes signed the minutes, signed the 10-K, signed the representation letters to the auditors, he knew it was wrong, and he did it anyway. That's a crime, and that's why we're here."

Reyes sat silently throughout the proceedings dressed in a dark suit, looking directly at his lawyer and the jury.

Marmaro cast Reyes as a hard-charging salesman who took San Jose-based Brocade from a struggling startup in the late 1990s to an industry leader in the data storage networking market. The company makes switches and software used to connect corporate servers and data storage systems.

Marmaro said Reyes relied on his company's corporate finance department to make sure that any expenses associated with the options grants were properly recorded. Noting that Reyes did not grant himself any stock options, Marmaro said Reyes had a "good faith belief" that the company's accounting practices were permissible.

"No one believed the company was committing securities fraud. No one believed the company was cheating shareholders and investors," Marmaro said in his nearly two-hour opening statement. "Everyone believed that Brocade's accounting practices and procedures were correct."

Reyes is being tried separately from Stephanie Jensen, Brocade's former vice president of human resources, who was charged with the same 12 counts as Reyes. Two mail fraud charges were later dropped for both defendants. A trial date for Jensen has not been set.

In May, Brocade and Mercury Interactive LLC, now owned by Hewlett-Packard (News - Alert) Co., became the first two companies to pay fines to settle allegations by the SEC of civil fraud accompanying backdating. Brocade agreed to pay $7 million and Mercury agreed to pay $28 million.

Backdating is not necessarily illegal if companies properly account for it. But a company can get into trouble if it doesn't properly record the compensation expenses associated with grants that are "in the money" when they are awarded, or have value because their exercise price is lower than the market value on the day of the grant.

Prosecutors say Reyes and Jensen helped try to hide the fact that the company awarded "in the money" grants by saying they were "at the money," a term that refers to the exercise price and the market price being exactly equal on the date of the grant. "At the money" grants do not incur compensation expenses.

Lawyers said they expect the trial to last about two months.

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