Former Brocade Communications Systems Inc. CEO Gregory Reyes was convicted Tuesday of defrauding investors in the first stock options backdating case to go to trial.
The guilty verdict on all counts is an important validation of the Justice Department’s options backdating probe, which has so far led to criminal charges against at least 10 executives. Reyes was seen as an important test of whether a jury considers it a crime deserving of jail time.
Reyes wiped his forehead with handkerchief and glared at the jury as the verdict was announced. His wife sobbed.
His conviction could embolden prosecutors in their ongoing options investigation. The government has reportedly been looking at filing criminal charges against former executives at Apple Inc., KLA-Tencor Corp. and Broadcom Corp., companies that have all acknowledged stock options shenanigans.
Reyes was charged with 10 felony counts of securities fraud, with prosecutors accusing him of doctoring company records and lying to investors and auditors about the company’s options practices to falsely boost Brocade’s profit. The trial, which lasted six weeks, went to the jury July 30.
Backdating refers to the practice of selecting favorable grant dates in the past when the company’s stock price was low, and retroactively pegging awards to those dates. The goal is to boost the recipient’s potential windfall, and it’s only illegal if it’s not properly accounted for.
Prosecutors said Reyes intentionally kept compensation expenses associated with Brocade’s options awards off the company’s books. His defense team argued he didn’t understand the accounting implications and relied on Brocade’s financial department to properly record the expense.
Reyes was charged last summer with 12 felony counts of securities fraud and other offenses. Brocade’s former vice president of human resources, Stephanie Jensen, was also charged with 12 counts. Two mail fraud charges were later dropped for both defendants.
The executives are being tried separately. A trial date for Jensen has not been set.
The government alleges the two illegally concealed that Brocade was awarding “in the money” grants — or options that already had value when they were given, thus requiring the company to incur compensation expenses.
By keeping the charges off the company’s financial records, prosecutors argued, the executives misled investors about the true profitability of San Jose-based Brocade, which makes switches and software used to connect corporate servers and data storage systems.
Some defense witnesses testified that options-related expenses weren’t even relevant in calculating Brocade’s core profitability and measuring the success of its operations.
Assistant U.S. Attorney Tim Crudo countered that the government doesn’t have to prove that Reyes knew which securities laws he was breaking, just that he knew what he was doing was wrong.
He said Reyes knew Brocade’s financial reports and board meeting records were incorrect but signed them anyway and also lied to auditors about the company’s options practices.
In May, Brocade and Mercury Interactive LLC, now owned by Hewlett-Packard Co., became the first two companies to pay fines to settle allegations by the Securities and Exchange Commission of civil fraud accompanying backdating. Brocade agreed to pay $7 million and Mercury agreed to pay $28 million.