July 20 (Bloomberg) -- Former Brocade Communications Systems Inc. Chief Executive Officer Gregory Reyes became the first CEO charged in the U.S. probe of illegal backdating and other manipulation of employee stock option grants.

Reyes, 43, ousted as head of the Silicon Valley maker of computer equipment in January 2005 after an earnings restatement, was charged with securities fraud in a criminal complaint filed today in San Francisco federal court. Also charged was ex-human resources vice president Stephanie Jensen. They were sued by the Securities and Exchange Commission along with former Brocade Chief Financial Officer Antonio Canova.

The criminal and civil allegations are the first in the biggest federal investigation of corporate wrongdoing since an inquiry into improper mutual-fund trading three years ago led to $4.3 billion in penalties. More than 66 companies are conducting internal inquiries or are under federal investigation. SEC Chairman Christopher Cox said today that his agency is investigating more than 80 companies in the matter.

``This is the tip of the iceberg,'' said George Stamboulidis, head of the white collar criminal defense practice at Baker Hostetler in New York. ``I think it is highly likely that more executives will be charged.''

Reyes lawyer Richard Marmaro rejected the government's charges, saying his client never profited from backdating.

No Profit

``Reyes is not even alleged to have granted himself any of the options at issue in the case, nor is there even an allegation that he made any money through the alleged option irregularities,'' Marmaro said in a statement. ``All he did was what his board authorized him to do.''

Reyes said that he had urged prosecutors during negotiations before today not to prosecute his client.

``The prosecutors were never interested in the facts of this case as far as Mr. Reyes is concerned,'' he said. ``They have their own agenda.''

Jan Little, a lawyer for Jensen, 48, of Los Altos, California, said the charges are ``wrongheaded'' and that her client is innocent.

``Jensen directed Brocade's human resources department, and she had no responsibility for finance or accounting,'' Little said in an e-mailed statement.

The charges that Reyes and Jensen backdated option grants for new hires and to retain existing employees come a week after San Francisco U.S. Attorney Kevin Ryan announced a task force was investigating whether individuals and companies were engaging in the practice, a popular means of attracting highly skilled executives and employees to technology companies.

If convicted, the defendants face up to 20 years in prison, $5 million in fines, and possibly a fine equal to twice the gain or loss caused by the offense, according to the government.

Manipulation

Backdating of options ``strikes at the heart of investor confidence,'' Cox said at a press conference. The U.S. probe aims to ``stamp out fraudulent backdating,'' he said.

The U.S. investigations of stock-options manipulation have cost at least 19 corporate officials -- including four CEOS -- their jobs. Newpark Resources Inc.'s James Cole and Comverse Technology Inc.'s Kobi Alexander are among chief executives who have been ousted.

Regulators are studying whether executives at companies ranging from Home Depot Inc., the world's biggest home- improvement retailer, to UnitedHealth Group Inc., the No. 2 U.S. health insurer, inflated the value of their options by backdating or timing the grants to coincide with days when the stock price was low.

An options contract gives the holder the right to buy or sell a specific quantity of stock at a later date, and usually at the price of the stock on the day of the grant.

Internal Review

In January 2005, Brocade announced that an internal review had found the company incorrectly accounted for stock options granted to newly hired employees and those working part-time.

The review also found there was ``insufficient basis'' to rely on the company's methods and documentation for determining the dates of option grants prior to August 2003, according to a filing with the SEC.

The company reported in the filing that, between May 1999 and July 2000, it set the price of options for new employees on the day they accepted a job rather than on the date they began working. Because Brocade's share price was rising between 1999 and 2000, new hires ended up receiving options at a discount to the company's share price on their starting date.

Record Changes

Accounting rules require Brocade to record changes in the value of discounted options in quarterly income, based on fluctuations in its share price. Brocade said it issued 98.8 million options between May 1999 and July 2003 that were subject to this ``variable accounting.''

Brocade, the world's largest maker of switches for storage networks with 1,316 employees, restated earnings twice last year because the company didn't properly account for options.

In an affidavit filed with the criminal complaint, FBI agent Joseph Schadler said Reyes was granted sole authority from Brocade's board to grant stock options and he was ``a committee of one'' for purposes of granting stock options.

Reyes and Jensen backdated employment offer letters and other personnel records so employees could be given stock option grants that ``were purportedly made and priced when the market value of Brocade's stock was relatively low,'' according to court papers.

Brocade Executives

The two Brocade executives tried to make it appear ``that those employees were actually employed by Brocade on the grant dates, when in fact they were not,'' the government said.

The Justice Department described one incident in which a Brocade employee was offered a job after Feb. 1, 2002, and the employee's offer letter, which included a stock option grant, was backdated to Nov. 28, 2001. After the employee accepted the job in February 2002, Reyes and Jensen ``prepared committee meeting minutes for the board of directors dated Nov. 28, 2001.''

The minutes priced the stock option grant using the closing price of Brocade's stock on Nov. 28, which was $28.82 a share.

``Reyes then signed the backdated committee meeting minutes approving the grant,'' the government said in court papers.

The SEC, in its civil complaint filed today, said that Reyes and Jensen, with the help of ex-Brocade finance chief Canova, defrauded investors by not properly accounting for the true value of the backdated option grants.

`False Portrait'

``By falsifying and backdating option paperwork, Reyes and Jensen knew investors would be given a false portrait of Brocade's financial condition,'' Linda Chatman Thomsen, director of the SEC's enforcement division, said in a statement.

Canova, 44, of Los Altos Hills, California, was ``warned in writing that option paperwork had been forged to enable an employee to get favorably priced options'' and failed to advise Brocade's auditors and signed false financial statements and SEC filings, the regulator claimed.

Patrick Murphy, branch chief at the SEC in San Francisco, said the defendants were ``required to record a compensation expense that would reduce the company's income.''

Norman Blears, Canova's attorney, didn't return a message left on voicemail seeking comment.

In Brocade's first restatement in January 2005, the San Jose, California-based company widened its 2004 loss to $32 million from $2 million because it misreported stock-based compensation.

In the second restatement, in November, the company added about $71 million in expenses because it didn't properly account for stock options previously issued to executives on leaves of absence or in advisory roles, such as Reyes, of Saratoga, California, who was replaced as CEO and then agreed to serve as an adviser to the company.

Stepped Down

Reyes stepped down from Brocade's board last year, and his advisory agreement was terminated in July. Reyes, who joined Brocade in 1998 as president and CEO, is on the board of the San Jose Sharks hockey team and Verisign Inc., where he is also a member of the compensation committee.

His father is Gregorio Reyes, who sits on the board of several technology companies, including Seagate Technology, and his uncle is George Reyes, chief financial officer at Google Inc.

Brocade in May 1999 held an initial public offering of 26 million shares at $2.38 each, adjusted for later stock splits. The shares hit an all-time high of $133.72 on Oct. 23, 2000.

Exercised

According to proxy statements, Reyes exercised stock options just one time after Brocade's initial public offering, earning $2.99 million by exercising options on 40,000 shares in fiscal 2000. His big gains came in December 1998, about six months prior to the IPO, when Reyes exercised options for the purchase of 12.3 million shares at 28 cents each.

Starting in September 1999, he sold almost 5.9 million common shares over the ensuing year, raising more than $354 million, according to SEC filings and data compiled by The Washington Service. He sold almost 5 million shares in February 2005 for about $30.7 million.

Reyes agreed to the cancellation of options on 11 million shares on Jan. 9, 2003, in return for the promise of a new grant that July. He ended up getting new options to buy 1.1 million shares at a strike price of $6.54 each.

The SEC opened an investigation into Brocade in June 2005 after the second restatement. The U.S. Justice Department joined the probe in May.

In May, Brocade said second-quarter profit fell 37 percent as expenses rose. Net income fell to $13.5 million, or 5 cents a share, from $21.4 million, or 8 cents, a year earlier.

Brocade stock fell 11 cents to $5.91 in Nasdaq Stock Market composite trading. The company, in an e-mailed statement, declined to comment on Reyes, Jensen or Canova.

None of the charges affected ``historical revenues, cash positions, or non-stock option related operating expenses,'' the company said.

The criminal case is U.S. v Gregory Reyes and Stephanie Jensen, 06-70450, U.S. District Court for the Northern District of California, San Francisco. The SEC complaint is SEC v. Reyes, U.S. District Court for the Northern District of California, San Francisco.

To contact the reporter about this story: Karen Gullo in San Francisco at kgullo@bloomberg.net.

Last Updated: July 20, 2006 18:39 EDT