New Stock Option Fears in the Valley

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Key Discrepancy Emerged

The most damaging evidence against Reyes may have come from Craig Martin, a lawyer with Morrison & Foerster, who led the internal investigation Brocade's board launched in late 2004. In his interviews with Reyes, Martin testified that Reyes denied that any grants had been backdated. Instead, he argued that he'd actually made the grants properly and that the reason it looked suspicious was that he only signed the paperwork days or weeks later, on forms carrying the date when he claims to have made the granting decision.

But in the trial, when numerous former Brocade HR staffers testified to picking low prices off of Yahoo Finance (YHOO), Reyes' lawyers did not contest that backdating had occurred. Instead, they argued that Reyes had no knowledge that any of it was illegal, or that any grants had not been properly accounted for. On Aug. 2, jurors requested transcripts of Martin's testimony.

That's a damning discrepancy, to be sure—but nothing like the e-mails found in other cases. For example, Gary Fischer, a former top executive with chipmaker Integrated Silicon Solution (ISSI), who recently settled with the Securities and Exchange Commission, admitted in an e-mail that he chose to grant options one day off a quarterly low in ISS stock. That way, auditors wouldn't suspect that the company was backdating. "[It] implies we tried to take advantage of the drop by quickly locking in on the following Monday," Fischer wrote. "Obviously the advantage is no P&L impact plus the person gets the upside of the remaining vesting."

In other cases, companies admit top executives' involvement. Apple disclosed last December that it had backdated 6,428 grants during Jobs' tenure, including two massive grants to Jobs. While it admitted that Jobs knew about the backdating and on some occasions even recommended the dates, the board "found no misconduct" in part because Jobs "did not appreciate the accounting implications," according to its filing.

Emboldened Prosecutors?

So will the Reyes decision once again put Jobs and other executives at risk? Scott Schools, the U.S. Attorney in the San Francisco office that won the conviction, downplayed any larger significance of the verdict. "A single jury, limited to the evidence in a single case, determined that a single defendant has violated the law," he said, according to press reports. And Jobs is most likely out of the woods. Two sources say it's highly unlikely that the Justice Dept. will come after Jobs or anyone currently at Apple.

But others say the Reyes decision could embolden federal prosecutors nationwide to go on the attack. That alone will surely lead many defense attorneys to think harder about settling with the government to avoid prosecution. Stamboulidis predicts that, "prosecutors and regulators will be able to extract larger penalties and settlements" from executives. Several sources suggest this could theoretically include former Apple chief counsel Nancy Heinen. Under her watch someone at Apple created minutes of a fictitious board meeting to grant Jobs options—just the sort of falsification that lies at the heart of the Reyes case. But Heinen's lawyer, Cris Arguedas, doesn't think the Reyes verdict will prompt prosecutors to seek more convictions. "Every case is different, with different evidence," she wrote in an e-mail to BusinessWeek.

Other observers agree that it's hard to jump to conclusions about DOJ's next steps, but for different reasons. That's in part because Justice is dealing with the turmoil surrounding Attorney General Alberto Gonzales and the personnel changes in many offices. "A lot of criminal defense lawyers are having a very difficult time trying to understand what the U.S. Attorneys are up to," says one defense lawyer involved in multiple backdating cases.

In any case, the Reyes conviction could lead lawyers to rethink what constitutes a great case for the government. Until now, it was thought that the best cases would involve a continued pattern of options shenanigans, even after the Sarbanes Oxley Act clarified and emphasized the need for careful options accounting rules.

Weighing Damage to Shareholders

But Brocade tightened its processes at the time, just as most tech firms did. Then there's the lack of direct evidence that Reyes knew he was breaking the law. That's considered to be critical, to counter defense lawyers' arguments that their clients had only followed the advice of the finance staffers, lawyers and accountants who created and approved the books. Lastly, prosecutors look for cases where there was substantial damage to shareholders—again, a hard case to make in the Brocade case.

Much of the trial involved discussion of whether investors cared when the company restated earnings to properly account for the backdated options. While the government argued that the company's shares did in fact fall on the two occasions when the company disclosed options-related restatements, the stock quickly bounced back. Unlike Enron, WorldCom and other cases of massive fraud, Brocade shares have remained roughly flat, dropping from $7 at the time of the first options-related restatement to $6.19 on Aug. 7. "If you've got investors losing their shirts like they did with Enron, you may need someone to blame. But there's nothing like that happening here," says University of Illinois law professor Larry Ribstein.

Ribstein is among those who fear that the Reyes decision will open the floodgates for criminal indictments on crimes they feel are best punished via the checkbook, as a result of civil penalties and settlements with the SEC. "This will clearly embolden the government to seek more criminal prosecutions—and criminal prosecutions are a very blunt instrument with which to go after conduct that involves a lot of nuance and detail," Ribstein says.

Burrows is a senior writer for BusinessWeek, based in Silicon Valley.