A Big Day in the Greg Reyes Options Backdating Trial

Lawyers in the trial to convict former Brocade Communications CEO Greg Reyes on securities fraud and related charges gave their final arguments yesterday (or most of them, anyway. Attorneys are expected to finish up today, and then the jury will get its instructions and begin its deliberations). The room was packed with lawyers and friends and family of Reyes, including Reyes’ father Greg Sr., a long-time chip industry executive, and his uncle George, the CFO of Google. Interestingly, given the media’s enthusiastic coverage of the emerging backdating scandal last year, there weren’t nearly enough reporters on hand to fill the two benches set aside for us.

That's too bad, because the final arguments, if nothing else, made it clear just how complex these cases can be.

To be sure, that's not the message the government wanted to convey. Assistant U.S. Attorney Adam Reeves started the day with a two hour presentation that sought to emphasize the bold simplicity of the alleged scheme. Citing testimony from a number of former Brocade human resources staffers, he argued that Reyes and former Brocade HR vice president Stephanie Jensen had those staffers routinely bring Reyes paperwork to sign that approved grants that he knew had been improperly backdated to days or weeks before, when Brocade's stock price was lower--and that this scheme had been concealed from Brocade's finance department. As a result, Brocade's unsuspecting number-crunchers had accounted for the options as though they'd been granted at the fair market value. That way, employees got their low-priced options, and Brocade didn't incur the non-cash compensation expenses that must be recorded for "in-the-money" options. That, say prosecutors, was what the scheme was all about: Reyes and Jensen's intention to cook Brocade's books by avoiding expenses that would have dragged down the company's net income.

On many occasions, the cool, confident Reeves struck a populist tone--equating Reyes with other white color crooks who do "what powerful people sometimes do...They cheat." He repeatedly referred to Reyes' own words and signatures to establish his guilt. For example, if Reyes didn't think non-cash compensation expenses were important to investors, as the defense has argued, why did he become actively involved with other tech CEOs in lobbying against options expensing earlier this decade--as is proven by letters he wrote in support of the effort? If there was no conspiracy to cover up, why did Jensen on at least three occasions chew out individual staffers for mentioning the options pricing program in an email? And the showpiece of the government's case was displayed on a poster on an easel just feet in front of the jury box: a 2004 e-mail in which Reyes, then a director on the board of VeriSign, admonishes fellow VeriSign director Jim Bidzos in all caps that "IT IS ILLEGAL TO BACKDATE OPTIONS GRANTS."

Dramatic stuff, to be sure. But by the time defense lawyer Richard Marmaro finished his own three hour performance, little about the government's case seemed so simple. Marmaro beseeched jurors to question why the prosecution had not come up with any direct evidence to prove the existence of a conspiracy--no emails between Reyes and Jensen, or testimony from people who overheard them discussing the scheme. He blasted the notion that the finance department had been kept out of the loop, citing various emails between HR and former Brocade CFO Mike Byrd and former controller Bob Bossi. He claimed that a detailed process manual written up by an HR staffer (which contained such damning steps as picking a low price off a Yahoo Finance chart to recommend to Reyes) was available to anyone on Brocade's computer network, and not hidden away. As for the note to Bidzos, Marmaro claimed Reyes was only arguing that backdating was illegal in the particular case Bidzos was asking about, which involved a grant to a top VeriSign executive. While backdating is legal for rank-and-file employees if properly accounted for, grants to top executives as defined by Section 16 of the Securities Exchange Act of 1934 must always be reported to the government within two days. That leaves almost no wiggle room to look back for a more attractive price. To bolster his point, Marmaro noted that the subject line on the email did in fact read "Proposed Section 16 Grants."

Marmaro repeatedly questioned why the government hadn't called the people who'd know best if an accounting fraud had occurred--Bossi and Byrd. And he made a compelling case that the reason for this was that they might have deep-sixed the government's case by testifying that they themselves--not Reyes--had okayed the backdating, based on their belief that it was proper based on accounting rules at the time. In one email to an HR staffer, for example, Bossi says it was okay for them to choose any date in the past to secure the lowest-priced options for employees, so long as it was before the quarterly books had closed. While Brocade's board later decided that this reading of the rules was incorrect and ordered a restatement, that doesn't mean Reyes had knowingly broken the law, Marmaro argued--just as it doesn't imply criminal activity at the 130-plus other companies that have made similar restatements. Rather, he said that Reyes, like any CEO, had relied on the judgment of his top financial lieutenants.

Marmaro piled on plenty more. Why, for example, did Reyes fire Jensen, his alleged co-conspirator, right in the middle of the alleged scheme in 2004? And why in 2003 did he okay a task force to improve the options granting program that prosecutors say he and Jensen so carefully rigged to hide illegal backdating? "If you're Greg Reyes, wouldn't you have said 'hands off that process, it's running just fine,?' asked Marmaro.

Many of the spectators in attendance in the courtroom felt Marmaro did a bravura job of introducing reasonable doubts for jurists to consider. There are still unanswered questions. Here's one: why have Reyes' lawyers argued in the past that he actually did make suspiciously low-priced grants in "meetings with himself," as allowed by the sweeping "committee of one" powers afforded him by Brocade's board, when in fact it now seems clear that HR staffers often picked those dates with the benefit of hindsight?

Now it's up to the jury to work through the inconsistencies, and who knows where they will end up. Still, having heard both arguments, it seems to me that the right issues are teed up for them to clarify the essential question: when should backdating violations result in stiff civil penalties and CEOs being forced out of their jobs, versus criminal charges with the potential for lengthy prison time.

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