Friday, February 9, 2007

Challenging the Brocade Fraud Charges

The defendants in the first options backdating prosecution, former Brocade CEO Gregory Reyes and HR manager Stephanie Jensen, are seeking dismissal of seven of the twelve counts of the indictment because the charges are tainted by a questionable theory of honest services fraud.  The defendants rely on the Fifth Circuit's decision in United States v. Brown, 459 F.3d 509 (5th Cir. 2006), in which the court overturned the convictions of defendants in the Enron Nigerian Barge trial because the government could not establish the defendants' intent to deprive the company of their honest services.  The key quotation in Brown is:

We do not presume that it is in a corporation's legitimate interests ever to misstate earnings--it is not. However, where an employer intentionally aligns the interests of the employee with a specified corporate goal, where the employee perceives his pursuit of that goal as mutually benefitting him and his employer, and where the employee's conduct is consistent with that perception of the mutual interest, such conduct is beyond the reach of the honest services theory of fraud as it has hitherto been applied. Therefore, the Government must turn to other statutes, or even the wire fraud statutes absent the component of honest services to punish this character of wrongdoing.

In the Brocade prosecution, neither Reyes nor Jensen received the backdated options, and they were doled out to entice prospective employees to join the company.  The use of the options as a means to attract good workers is arguably a goal "mutually benefitting [them] and [their] employer" so the backdating could be viewed as "consistent with that perception of the mutual interest."  The government urged the District Court to reject Brown as controlling precedent, and asserts that the indictment is sufficient to go to trial without the court having to determine what theory will support a conviction. (Briefs available below)

The Fifth Circuit decision could turn out to be a significant problem for federal prosecutors if it spreads to other circuits.  The court's view that employees who believe their interests are aligned with the employers could make it much more difficult to prosecute honest services fraud cases when the defendant does not directly receive a pecuniary benefit from the breach of fiduciary duty.  Perhaps even more troublesome for the government would be if courts applied Brown outside of private honest services fraud cases to those involving public officials.  Many of those cases involve dishonest conduct but not direct financial gain to the official, and it could be difficult to pursue cases if it were a good defense that the defendant "perceived" his or her interest as being aligned with the government

The defendant filed a petition for certiorari in Brown on January 16, 2007, and the government has until mid-March to respond.  It will be interesting to see if the Solicitor General seeks to have the Fifth Circuit's honest services analysis overturned by the Supreme Court.  The danger in seeking cert, of course, is that an unfavorable decision would have a broad impact on honest services fraud cases of all types.  Then again, after the Court took a narrow view of the mail fraud statute in McNally v. United States, 483 U.S. 350 (1987), Congress promptly enacted Sec. 1346 to restore the right of honest services theory.  The current atmosphere of curtailing corruption could work in the government's favor. (ph)

Download brocade_mail_fraud_brief_jan_2007.pdf

Download brocade_mail_fraud_u_s_opposition_jan_2007.pdf

Fraud, Prosecutions, Securities | Permalink

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