Ex-Brocade Execs Charged With Fraud

SAN FRANCISCO — The U.S. attorney's office and the U.S. Securities and Exchange Commission (SEC) have separately filed criminal and civil securities fraud charges against the former CEO of Brocade Communications Systems Inc. and another former high-ranking executive with the firm, according to a statement released by the U.S. attorney's office Thursday (July 29).

The charges mark the first formal criminal and civil securities fraud charges brought against any of the dozens of companies that have been implicated in a controversy over historical stock options granting practices. The controversy generally concerns the concept of backdating stock options, retroactively dating them at a time when a company's stock price is relatively low, increasing the potential for profit.

The complaints allege that Gregory Reyes, former president, chairman and CEO of Brocade, and Stephanie Jensen, former Brocade vice president of human resources, routinely backdated stock option grants to give employees favorably priced options without recording necessary compensation expenses. The charges are the result of 18-month investigations by the SEC and the FBI, according to U.S. attorney's office.

Speaking at a news conference at the SEC district office here Thursday, SEC Chairman Christopher Cox, said the SEC alleges that Reyes and Jensen participated in an options backdating scheme for more than four years and that the scheme inflated Brocade's net income by as much as $1 billion in 2000 alone. Cox said the SEC's division of enforcement is currently investigating more than 80 companies nationwide for potential backdating impropriety."This issue is important because it goes to the heart of the relationship between companies and shareholders," Cox said.

Cox and Linda Chatman Thomsen, director of the SEC's enforcement division, showed data that indicated that all of Brocade's 2002 stock option grant dates coincided with quarterly or monthly stock price lows.

If convicted on the criminal charge, Reyes and Jensen could get five to 20 years in prison and face a fine of $5 million each, according to U.S. Attorney Kevin Ryan. The two are expected to appear in federal court here Aug. 2, he said.

Officials declined to comment further on other companies being investigated. Ryan would not say how many companies are currently being looked at by the U.S. attorney's office, other than to say the backdating task force has "several" investigations ongoing. A number of companies have acknowledged receiving subpoenas from Ryan's office in SEC filings.

The complaints allege that Reyes and Jensen regularly caused Brocade to grant stock options below market price to employees between 2000 and 2004, but backdated documents to make it appear that the options were granted on prior dates, concealing millions of dollars in expenses from investors.The separate criminal and civil complaints allege that Reyes repeatedly used hindsight to select a date with a lower stock price from the recent past as the supposed option grant date. To facilitate the scheme, Jensen allegedly created or directed others to create paperwork that made it appear that the options had been granted on the earlier date, according to the criminal complaint.

Officials implied that they anticipated bringing charges against other companies. But Thomsen added of the 80 plus ongoing investigations, the SEC is "not certain in any one of them" (other than Brocade) that the evidence involved will merit charges being filed.

Ryan acknowledged that statutes of limitations might be a factor in some investigations, though not in the Brocade case. Because some of the alleged illegal activity is said to have occurred in the late 1990s and early part of this decade, it is possible that it may be too late to file complaints in some cases.

"We are looking at statute of limitations and some of the issues around that," Ryan said.

The backdating scheme at Brocade is alleged to have occurred between 2000 and 2004.Officials would not rule out the possibility of other Brocade employees being charged, though Ryan said Reyes is alleged to have acted as a "committee of one" with sole authority to grant stock options on dates of his choosing. Ryan and Thomsen said multiple times that the Brocade investigation is ongoing.

Brocade eventually restated its financial results for 1999 through 2004 as a result of stock options grant irregularities, resulting in revised results. For example, according to the complaint, Brocade's income for 1999 through 2001 declined by a total of $304 million after the restatements.

The SEC's civil complaint also names Antonio Canova, Brocade's former chief financial officer, who is alleged to have learned of the backdating after joining Brocade. According to the complaint, Canova was warned in writing that option paperwork had been forged to enable an employee to get favorably priced options, yet failed to advise Brocade's auditors or its audit committee. The complaint alleges that Canova knowingly signed false and misleading financial statements and SEC filings.

"The criminal charges filed today allege that this backdating scheme contributed to the restatements of hundreds of millions of dollars of Brocade's financial results," said Ryan, leader of a stock options backdating task force.

The criminal complaint, filed in federal court here, charges Reyes and Jensen with securities fraud. The SEC's civil complaint, filed in federal court in San Jose, Calif., charges Reyes, Canova, and Jensen with fraud and other violations of federal securities laws.Reyes's attorney, Richard Marmaro, of Los Angeles firm Skadden, Arps, Slate Meagher & Flom, issued a statement proclaiming Reyes's innocence.

"Greg Reyes is innocent, and if necessary, we will prove his innocence in a court of law," Marmaro said in the statement. "Financial gain is always the motive in securities fraud cases, and here there was none. There is not even an allegation of self-enrichment, or self-dealing. Nor is there any evidence of an intent to misstate the financial statements of the company."

Ryan said he does not have to prove that Reyes and Jensen gained financially from the alleged backdating scheme in order to make a case against them.

"There are many reasons why individuals would engage in this kind of behavior," Ryan said. "Self enrichment is one of them, but there are others. I don't feel it's necessary to prove that the executive profited personally."

Brocade (San Jose), a provider of computer networking equipment, issued a statement Thursday afternoon to say it has strengthened internal disclosure practices since the alleged backdating came to light. No executives involved in the historical stock option granting practices remain employed with Brocade, the company said.Brocade said it set aside $7 million during the first quarter of this year for a proposed settlement with the SEC. The $7 million is based on an offer of settlement that Brocade made to the SEC staff and which the staff has indicated it would recommend to the SEC commissioners, Brocade said.

The proposed settlement is contingent on the SEC commissioners' approval, Brocade said. The company had no comment with respect to charges filed against Reyes and Jensen.