Greg Reyes Exonerated On Options Backdating. Why That's A Good Thing.

Posted by: Peter Burrows on August 19, 2009

I’ve covered Greg Reyes’ legal woes around options backdating from the very start—from the time word was just starting to zip around Silicon Valley that the Justice Department was looking for a “poster child” to prosecute for improper accounting of this form of compensation. I saw the once-swaggering Reyes go from being terrified (not to mention ostracized overnight in clubby tech circles) in those early months, to furious at what he felt was a politically-motivated crusade by the Bush Administration’s DOJ to appear tough on corporate crime (he’d point to the Bushies’ need to distance themselves from its close ties to former Enron chief Key Lay), to utterly despairing as it became clear he was going to lose the case. But through it all, I was struck by his insistence that he was innocent and would be exonerated.

Yesterday, that’s what happened. In a 21-page finding, a US Circuit Court of Appeals threw out the verdict that was to have sent him to jail for 21 months and cost him $15 million in fines. At this point, the Department of Justice—Obama’s DOJ, not the Bush DOJ that made backdating such a front-burner issue—hasn’t said whether it will retry the case or seek to have the appeal overturned. That seems highly unlikely, in part because the government’s case against Reyes, the former CEO of storage maker Brocade Communications, turned out to be so controversial.

The trial was marked by charges of bullying of key witnesses, one of which later recanted her testimony. And Judge Mary Schroeder of the US Court of Appeals for the Ninth Circuit cited prosecutorial misconduct in reversing Reyes’ conviction, which had been based on the argument that Reyes had hidden the illegal backdating from his own finance department. Turns out that prosecutors knew but failed to disclose to the jury that two former Brocade executives—controller Bob Bossi and CFO Tony Canova—had told the FBI that they were aware of the practice. And get this: soon after Reyes was convicted, Brocade brought civil suit against Reyes and others including Canova and his predecessor as CFO, Michael Byrd, with having colluded in the scheme. (From the start, even before he was indicted, Reyes told me he’d relied on Byrd and his team to make sure the options were properly accounted for and thus legal—and fumed at Brocade and Byrd, once a close friend, for not coming to his defense. And at the government, for not compelling Byrd to testify so as to make its case against Reyes stick).

As such, this would be a satisfying final chapter of the Reyes saga. For starters, on legal grounds. Schroeder notes in her opinion that prosecutors not only withheld information about Bossi’s and Canova’s admissions, but then brazenly criticized Reyes’ lawyers before the jury for even suggesting that they knew of the backdating. Schroeder writes:

“Defense counsel made no knowingly false statements. The prosecutor did. Indeed, on appeal the government does not seriously dispute the falsity of the prosecutor’s statements of the duty of the prosecutor to refrain from making such statements. Instead, it argues the misconduct was harmless.”

Not to Reyes, it wasn’t.

Then there’s the fairness issue. Until yesterday, Reyes was sure to go through life tarred with the “only CEO to go to jail for backdating” label. Whatever you think about the practice of backdating (more on that later), there’s no doubt that he bore far more than his share of the blame for a practice that was common in Silicon Valley in the 1990s. To a great degree, this was because Brocade happened to be one of the first companies to come to the attention of regulators. Reyes also ended up as backdating poster boy because his case turned into such a can of worms for the US Attorney. After much tough talk, the government settled most of its other backdating cases and didn’t bring cases at all in other cases where backdating clearly occurred—such as at Apple, where Steve Jobs admitted his role. By the time the criminal proceedings against Reyes had gotten rolling, it was becoming clear that backdating cases weren’t going to be the slam dunks the government had figured on.

Now, let’s hope this is where the great backdating scandal finally fizzles out for good. Yes, backdating is a sleazy practice, but it’s one that was adopted by hundreds of companies on the advice of lawyers and accountants in the years before Sarbanes Oxley and other rules changes clarified the do’s and don’ts. Simply put, it was a gray area. What’s more black and white, with the benefit of hindsight, is this: that the government would have been far better served putting its crime-fighting resources into investigating excesses on Wall Street, out-of-control mortgage lending and Madoff-style Ponzi schemes. It still would.

Reader Comments

Senior

August 19, 2009 4:01 PM

Peter, great article
Very well done
Senior

Rodney

August 19, 2009 8:54 PM

Excellent article. One must wonder who, really, deserves the stigma of moral turpitude. The CEO who provides his employees the benefit of the doubt as to gray areas in stock option grants in order to retain talent (and quite reasonably relies on his finance experts to stay within the limits of the law), or the "public servant" attorney, wielding the awesome power of the government, who out right lies to the jury, the judge, and the public to secure "the kill" he personally believes ought to be the outcome? The former sounds like a smart business tactic likely benefiting shareholders (and one widely practiced, as a result). The later sounds like a complete inversion of "due process" and conduct that every citizen ought to be outraged was performed in the name of "the people."

Holly Tate

August 19, 2009 9:36 PM

Peter -

You clearly have a handle on this issue. Backdating of stock options - while not ethical - was not illegal. If only the government had spent their time and energy on all the tips they got about Bernie Madoff- or the banking crisis driven by a crazy mortgage market with no legs. If only they had focused on real issues impacting the economy. Imagine where we would be today.

ronald

August 19, 2009 10:16 PM

Backdating was clearly stealing from shareholders if not disclosed. Theft is a horrible thing. You can't justify illegal behavior by saying "my lawyer told it was ok." Unless you are a third grader, that argument does not work anymore.

Midwest

August 19, 2009 11:00 PM

To note that backdating "is a sleazy practice" is one of the bigger understatements of the year. It is stealing, plain and simple and the practice was meant to do little more than line the pockets of already very well paid people. I'm not up on all the specifics of this case but all of those that profited by CHEATING on their stock options should be forced to pay back all of their gains on all of the exercised options. To enrich those lucky enough to get options at the expense of the shareholders is thievery, plain and simple.

Herschel

August 20, 2009 10:40 AM

What does the wealth of the beneficiaries of (in this case Brocade employees) have to do with the legality of backdating?

"Lucky enough to get options at the expense of shareholders"?

It is those employees who created Brocade's wealth. Without them, there would be no Brocade, no profit, no shareholders.

kumar

August 20, 2009 2:29 PM

Backdating was widespread and systemic in the tech industry and although highly unethical wasn't exactly illegal if accounted for. Brocade's crime was not accounting/expensing for the backdated options. In Reyes's own words, It is only illegal if we get caught, when referring to backdating. Reyes was lucky to get off on a technicality, but hardly innocent.

Bob L.

August 22, 2009 3:53 PM

Mr. Neal Dempsey is the real man to blame for the Brocade stock option debacle. Sure, Greg Reyes is a crook, but Neal Dempsey who was on the committee and a confidant of Mr. Reyes should be
implicated for his role in this conspiracy to defraud ordinary shareholders
for
millions of dollars. Mr. Dempsey has consistently demonstrated a pattern of
committing to a plan and executing another and getting rewarded for failure.
Through his hey days were in the early 90’s, I worked with Mr. Dempsey. I am
guilty of
not blowing his cover because my enterprise went on to make me considerable
wealth and I chose the path to enjoy the wealth. Mr. Dempsey however, rarely showed up

to Board meetings and when he did, he did not contribute much to my business. He was good at taking the other board members out to expensive restaurants and
inserting himself in different processes. But his value add on my board was a little less than zero.
Yes, it is a rant. I am trying to demonstrate a consistent pattern of
incompetence that leads to borderline legal behavior to cover up for the
incompetence.

He also pledged 13 million dollars to the University of Washington to show what a “great human being he is” only to not pay up. I think he ended up giving only $250k and used it as a tax write off or shelter. Now he is trying to wash his hands and get the case thrown out by Judge Charles Breyer and he along with Sonsini, Antono Canova and Seth Neiman are trying to get the charges thrown out or dismiss with prejudice. Dempsey paid $200k I think Canova $160k to wash their hands....

I am not sure who will be paying it but the 160 million they have pay the stockholders should also come from them as everyone got screwwed by them.
Stay tuned - I have time on my hand to go unearth more about Mr. Dempsey.

X-Brocadian

August 23, 2009 10:57 PM

Great article Peter.

Having been there and known everyone involved in the case, it has been extremely difficult to see the destruction this case took on many innocent Brocade employees and their families.

The public is now finally finding out the truth of what really happened. I have known for years what the government did to many of the witnesses. Bullying them into working in empty rooms for weeks on end going through their old files. Threatning Brocade with obstruction of justice if they didn't pull out witnesses to be at their beck and call for weeks and into months.

The big conspiracy should really be what the government and DOJ did under Bush's regime. If you thought it was only going on in Iraq. No, it was going on in Silicon Valley and the intimdation tactics used by the goverment to get "witnesses" to falsely make claims about Greg's role.

I've always been proud of having worked for Greg and if I were to see him again, I would proudly shake his hand, and grab him into a hug. No one but other Brocade employees who were there can recall how hard Greg worked to keep the company alive during the early 2000s. And the sacrafices he made for all his employees and the company.

I'm proud of my friends and former colleagues who didn't let the government have the final word. The truth came out, and yes, our faith in the justice system did finally prevail.

aubrey

August 24, 2009 5:32 PM

If he is as innocent as you all believe, then why did he use the statement "that (backdating) its only illegal until you get caught”?

This is a simple of case of someone getting caught and using their financial means to weasel their way out of the slammer. On 9/11/01 alone he backdated over $100 mil in stock option to take advantage of the stock market being closed, and he is innocent?

I hope to God the goverment retries it!

Colin Broughton

August 26, 2009 5:46 PM

The US justice system is crooked as a dogs hind leg.
I really don't understand how our American friends can tolerate such a travesty.
In Canada, this degree of prosecutorial misconduct would -at a minimum- result in disbarment.
And then there is the US love for plea bargaining, i.e. coercing innocent defendants to plead rather than face a crooked, rigged justice system complete with medieval penalties.
Frankly, I think Canada should stop extraditing people to the US until Americans clean up their act.

Bob L.

August 26, 2009 9:26 PM

Its true that the US justice system is crooked. But these guys are far from saints! I know them personally, have lived , worked, ate and dealt with all of them and I guarantee you they are also CROOKED COMMON THEIVES!

Aubrey

August 27, 2009 12:28 PM

"Oh but its only illegal if you get caught"!

Greg Reyes

Mike Palmer

October 12, 2009 12:02 AM

Backdating stock options is not illegal if the actual dates on which the documents were signed are shown on the documents.
However, falsely placing a date of February 5 on a document that was signed on May 10 of the following year is fraudulent and illegal. (It constitutes a fraud on the IRS as well as on shareholders.)
It is the latter conduct which appears to have become commonplace. That it was widespread or that lawyers and accountants conspired in the practice makes it neither right nor legal.
Everyone intelligent enough to be receiving stock options knows that putting false dates on documents is wrong. (Why would they not put the true dates on them if they were not trying to deceive someone?) It is not a gray area.

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Bloomberg Businessweek writers Peter Burrows, Cliff Edwards, Olga Kharif, Aaron Ricadela, and Douglas MacMillan, dig behind the headlines to analyze what’s really happening throughout the world of technology. Tech Beat covers everything from tech bellwethers like Apple, Google, and Intel and emerging new leaders such as Facebook to new technologies, trends, and controversies.

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