U.S. News

Brocade Trial Seen As Test for Options Backdating Cases


Prospects for criminal prosecutions of scores of options-backdating cases rest heavily on the outcome of a jury trial in which the judge has already questioned the strength of the government's evidence.

The case against former Brocade Communications Systems

Chief Executive Gregory Reyes, 44, may be decided soon by a jury that began deliberating his fate on Monday. A guilty verdict is anything but certain, analysts said, and the judge has said he could dismiss the charges in case of a conviction.

"Everybody is watching it with respect to how a jury will respond to these kinds of allegations," said attorney Charles Ross, former head of the white collar defense group at Herrick, Feinstein LLP.

"It's a pretty strong case for the defense, but if there's a conviction, the Justice Department will be emboldened to bring these coin-toss cases" where the outcome is uncertain, he said. Brocade is such a case, he added.

Experts said it may be difficult to convict Reyes because both sides agree he did not profit personally from the backdating, in which option grants were retroactively priced on days when Brocade's stock was low, maximizing gains for employees. San Jose, California-based Brocade is the world's largest maker of data-storage network switches.

The lack of a personal financial motive distinguishes the case from more-notorious securities-fraud cases such as Enron and Worldcom, observers said. While prosecutors are not required to prove that Reyes profited personally, jurors may be more lenient if he did not do so.

"If I were a prosecutor, I'd be reluctant to bring a case against a guy who didn't make any money on the deal," said Joseph Bartlett, an attorney at Fish & Richardson in New York and a former acting professor at Stanford Law School. "I don't think it's in the same category as the Enron or Worldcom game," where executives reaped large personal gains.

Many of the criminal options backdating cases announced so far involve allegations of personal gain by the defendants. The U.S. Securities and Exchange Commission is also investigating backdating, and about 100 companies have announced restatements totaling more than $12 billion to account for past options grants.

Other criminal backdating cases, many of which have resulted in guilty pleas, have been more straightforward than Brocade, Bartlett said. For example, former Monster Worldwide Inc <MNST.O> general counsel Myron Olesnyckyj pleaded guilty in February to criminal options-related fraud charges and admitted in court that he gained $381,000 from backdating schemes.

Comverse Technology's former CEO, Jacob "Kobi" Alexander, is in Namibia fighting extradition to the United States to face charges that he and others backdated millions of stock options for themselves and other employees when the shares were trading at lows.

In the Brocade case, Judge Charles Breyer of U.S. District Court in San Francisco expressed doubts about the government's case in a hearing last month after defense attorney Richard Marmaro asked him to acquit Reyes in mid-trial, citing insufficient evidence.

"What evidence is there that he actually understood the accounting implications of the backdating of the stock?" Breyer asked Assistant U.S. Attorney Timothy Crudo in the hearing.

The jury's decision is likely to influence the roughly 100 pending criminal investigations into backdating, a practice that prosecutors say enriched executives and other employees at the expense of shareholders through accounting manipulations.

An acquittal could make prosecutors think twice about bringing criminal charges in other backdating cases in which personal gain was not a motive and evidence of intentional wrongdoing is not obvious.

In addition to Reyes, the U.S. Justice Department has filed criminal charges against former executives of companies including McAfee, Comverse Technology, Monster Worldwide and Engineered Support Systems.

"It is an area that is relatively new in terms of the charges out there," conceded Michael Garcia, the U.S. Attorney for the Southern District of New York, in a July 25 Reuters interview. He added, however: "I am fairly confident that we are going to see more options charges."

Complicating criminal backdating prosecutions of Silicon Valley companies are recent personnel changes in the San Francisco U.S. Attorney's office, which took a leading role in such cases early on.

The office's former director, Kevin Ryan, was among federal prosecutors ousted last year in a Justice Department shake-up that has prompted a U.S. congressional investigation. Christopher Steskal, the assistant U.S. attorney who first headed the Brocade case, has left the office for a job in private practice.