New Stock Option Fears in the Valley

The feds' big win in the options backdating case against ex-Brocade CEO Greg Reyes has many wondering if this is only the start for prosecutors

by Peter Burrows

Attention, executives at the 200 or so companies that have been involved in the options backdating scandal that dominated many boardrooms last year. You may not be as safe as you thought you were from criminal indictments.

That is the most likely takeaway from the Department of Justice's surprisingly lopsided victory in its case against former Brocade Communications Systems (BRCD) Chief Executive Officer Greg Reyes, who was found guilty Aug. 7 on all 10 of the charges levied against him. Reyes, who spent roughly $30 million on his defense, faces up to 20 years in prison and millions of dollars in fines, not to mention possible civil judgments from the shareholder suits that could be sparked by his conviction.

Reyes will appeal the verdict, says his lawyer. "Today, we are disappointed. Tomorrow, we will continue the fight," said Rich Marmaro, of Skadden, Arps, Slate, Meagher & Flom, in a statement.

No Smoking Gun

It's not just the 10-0 victory (one that was belied by the emotion on display when the verdict was read, as more than one juror cried) that is putting lawyers for other technology executives on notice. It's that the facts in the case against Reyes set a low bar for prosecutors to clear, should they choose to bring more cases.

For starters, Reyes—unlike executives such as Apple (AAPL) CEO Steve Jobs and former United Healthcare (UNH) CEO Bill McGuire—did not receive backdated options himself. "This will set a tone that an executive can have mens rea—"a guilty mind"—even if he didn't personally line his own pockets," says George Stamboulidis, head of Baker Hostetler's white-collar defense practice. That's important, as an element of the securities fraud, false statement and records falsification charges on which Reyes was convicted requires that the defendant understand that his or her actions were illegal.

What's more, the case against Reyes included no blockbuster smoking guns to prove that he knowingly broke the law. For example, the government had no overheard conversations or e-mails in which Reyes admitted his involvement in the alleged scheme with former Brocade human resources chief Stephanie Jensen. The pair, prosecutors say, routinely falsified paperwork so that Brocade's finance department would process it without incurring accounting charges required for options grants given at below the market price.

Rather, the government made the most of Brocade's clear pattern of granting options on days when the stock was low, together with a smattering of damaging but not definitive testimony. One former HR staffer said Reyes once told her "it's not illegal if you don't get caught," but couldn't remember if they were talking about backdating at the time. On another occasion, in 2004, Reyes sent an e-mail to a fellow board member of VeriSign (VRSN) in which he declared, "IT IS ILLEGAL TO BACKDATE OPTIONS GRANTS."

While the government argued this was proof of his knowledge of accounting rules, Reyes' lawyers argued that Reyes was referring solely to a new reporting clause in the Sarbanes Oxley Act of 2002 that involves only grants to top executives—not the broader grants to rank-and-file employees that provided the basis for Reyes' conviction.