UPDATE: Brocade Ex-CEO Found Guilty

THE WALL STREET JOURNAL) By Steve Stecklow and Peter Waldman Gregory Reyes, the former chief executive of Brocade Communications Systems Inc., was convicted of securities fraud in the first criminal trial over the backdating of stock options. The verdict in U.S. District Court in San Francisco was a major victory for the government and is expected to stoke the pursuit of other executives for backdating. One of the prosecutors in Mr. Reyes's trial, Assistant U.S. Attorney Timothy P. Crudo, is involved in deciding whether to bring criminal charges over backdated options at Apple Inc. "To get a conviction with these facts, which weren't all that strong, will encourage the government to continue prosecuting backdating cases," said Phillip Stern, a Chicago lawyer and former enforcement official with the Securities and Exchange Commission. Some 140 companies have come under federal investigation for backdating, and about 70 executives have lost their jobs as companies conducted internal probes. Mr. Reyes was convicted on 10 counts including fraud, falsified accounting, conspiracy and filing false financial statements. After the verdict was read, his wife sobbed, as did some jurors. Mr. Reyes hugged his wife and members of his defense team before checking in with federal probation officers. Mr. Reyes's lawyer, Richard Marmaro, issued a statement saying his client was innocent. "We are confident he will ultimately be exonerated. At all times, he acted in the best interests of the employees and shareholders of Brocade," Mr. Marmaro said. The trial, in which jurors heard five weeks of testimony, was closely watched by executives, lawyers and other corporations caught up in the options scandal. Kevin Ryan, the former U.S. attorney in San Francisco who filed the Reyes indictment, said Mr. Reyes's conviction is sure to "invigorate" the prosecution of backdating cases, about half of which are in the San Francisco office. "Now we have some guidelines; the standard has been set," he said. Mr. Ryan said there was "keen interest" by his former bosses at the Department of Justice in Washington in the Brocade indictment and other backdating cases. He said he briefed former Deputy U.S. Attorney General Paul McNulty on his decision to pursue the case, and gave Mr. Reyes's attorney, Mr. Marmaro, several chances to explain his theory of his client's behavior. Mr. Reyes, who faces up to 20 years in prison, was accused of defrauding Brocade shareholders between 2000 and 2004 by conspiring to alter the grant dates of stock options awarded to employees and of falsifying documents, including the company's financial statements, to cover up the scheme. The company, based in San Jose, is a data-storage networking firm. A stock option gives its holder the right to buy shares at a future date at a fixed price, usually the market price on the date of the grant. If the stock later rises, the recipient can cash in the option for a profit. By backdating a grant to a prior date when the price was lower, the award's value increases and the option is instantly "in the money." During the trial, the defense didn't contest that stock options were backdated at Brocade -- Mr. Marmaro termed them "periodic look-backs." He conceded the options were improperly accounted for because they weren't recognized as compensation expenses in Brocade's financial statements as accounting rules required. At issue was whether Mr. Reyes understood that what the company was doing was wrong. The prosecution maintained that Mr. Reyes engaged in a conspiracy with Stephanie Jensen, Brocade's former head of human resources, to backdate options to recruit and retain employees, and then repeatedly falsified meeting minutes to hide the practice from accountants and ultimately investors. The prosecution called as witnesses several former human-resources employees who described how they selected earlier option-grant dates and prepared phony minutes of options-granting meetings that Mr. Reyes later signed. Several employees testified they felt uncomfortable with the practice. Ms. Jensen also faces criminal fraud charges and will be tried separately, although no trial date has been set. The government also claimed that Mr. Reyes later lied about the backdating practice to a law firm Brocade used to review its options-granting procedures. Prosecutors argued that Mr. Reyes understood that "in-the-money" options should be expensed and introduced into evidence a 2004 email in which he wrote, "It's illegal to backdate options grants." Despite this knowledge, they said, he signed financial statements, including annual reports, falsely stating that the options were granted at "fair market value," meaning they weren't in-the-money. "Amazingly in this case, the defense seems to have gone to extraordinary lengths to cast doubt on the veracity of the defendant's own certification," Assistant U.S. Attorney Adam A. Reeves said in his closing argument. "That defense is the corporate equivalent of 'The dog ate my homework.'" Mr. Marmaro said in his closing argument that Mr. Reyes was "a sales guy" with no background in accounting, and that Brocade was no different from many other companies that engaged in options backdating. "That accounting opinion that was at the heart of this case was, indeed, widely and in good faith misrepresented or misinterpreted and misapplied by hundreds of companies," he said. Mr. Marmaro also argued that "in-the-money" options are noncash expenses and therefore aren't of concern to investors. And he noted that Mr. Reyes never granted any backdated options to himself. "This is not a case of a CEO lining his own pockets," Mr. Marmaro said. He argued that Mr. Reyes only wanted to retain good employees and had no intention of defrauding shareholders. Mr. Reyes is the latest in a series of white-collar defendants to be convicted of fraud after arguing they were too busy and had too many responsibilities to realize what they were doing wrong. "The jury isn't going to sit there and buy that somebody was just too busy to know what his job is and points the finger at others," says Mr. Stern. Adds C. Hunter Wiggins, a former SEC lawyer who now practices with a private firm in Chicago: "That story line only works in legally gray areas concerning hypertechnical accounting rules." U.S. District Court Judge Charles Breyer scheduled Mr. Reyes' sentencing for Nov. 21. The judge, who said he would consider routine motions for a retrial this month, has wide latitude in punishing Mr. Reyes, former prosecutors said. He can decide, for example, that all 10 crimes for which Mr. Reyes was convicted stemmed from the same scheme thus reducing possible prison time. The judge can also opt for leniency for Mr. Reyes based on his own interpretation of the evidence at trial, said Bill Leone, a Denver lawyer and former U.S. attorney there. Though Judge Breyer, ruling last Friday, refused to grant Mr. Reyes's request to dismiss the case, the judge did express doubts, after the prosecution rested its case, about whether Mr. Reyes knew he was violating any laws. To date, 16 executives at eight companies have been charged with criminal offenses related to backdating. Seven have pleaded guilty. One has fled to Namibia and is fighting extradition to the U.S. The government has recently closed some of the 140 investigations it opened without taking action. Mr. Reyes still faces civil charges filed by the SEC. On May 31, Brocade agreed to pay the SEC $7 million to settle charges over backdating. Mr. Reyes holds a stake in the San Jose Sharks hockey team and hails from a family of high-tech entrepreneurs. His uncle, George Reyes, is chief financial officer of Google Inc. Gregory Reyes never exercised any of the questionable stock options at Brocade. He sold at least $380 million of shares he received before the company went public in 1999. The company dismissed him in mid-2005 after its stock-options problems became known.