Thursday, August 9, 2007

Will the Reyes Conviction Lead to More Options Backdating Prosecutions?

The conviction of former Brocade Communications CEO Gregory Reyes on fraud charges for options backdating may well embolden prosecutors in San Francisco and elsewhere to pursue criminal cases against other executives. There is one prosecution already pending against the former general counsel of McAfee, then known as Network Associates, that is similar to the Reyes indictment (indictment here).

The SEC has been more aggressive lately in filing civil enforcement actions against senior executives related to options backdating, and those cases may soon be ripe for criminal prosecution if there’s sufficient evidence to establish intent to defraud. Among the SEC cases filed recently that could conceivably trigger criminal charges include:

  • KLA-Tencor and its former CEO (here).
  • Mercury Interactive, which is now part of Hewlett-Packard, and its former CEO, two former CFOs, and its former general counsel (here).
  • Apple Inc.’s former CFO and former general counsel (here), although the company has not been charged at this point.

The Apple investigation involves backdated options awarded to company co-founder and CEO Steve Jobs, perhaps the rock star CEO of a Silicon Valley company. To this point, the SEC has not pursued any charges against Jobs, even though the company found that he had some participation in setting the price for the options.  I think it is quite unlikely prosecutors would pursue charges against him unless a "smoking gun" document or testimony from a highly credible witness emerges.

Each case has factors different from the Reyes prosecution. Many of the former executives from these companies received backdated options so that they would benefit personally, something that did not happen at Brocade yet the government was still able to obtain a conviction. On the other hand, Reyes was deeply involved in the options process by acting as a "committee of one" to make the awards, and he apparently made admissions – "It’s not illegal if you don’t get caught" – that may have eased the burden of proving intent to defraud.  The involvement of other potential defendants will likely vary.  A conviction in one case does not mean others will turn out the same, but federal prosecutors have to like their chances if they choose to bring new cases. (ph)


UPDATE: An earlier version of this post noted that Reyes had been convicted of mail fraud under the right of honest services theory.  That theory was dropped from the trial and so is not an issue in his case.  Thanks to a reader for pointing out the issue. (ph)

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Last weeks conviction of former Brocade chief executive officer Gregory Reyes of stock option backdating continues to send shivers through Silicon Valley.More indictments are likely to follow, reports the ISS corporate governance blog.In the Whit... [Read More]

Tracked on Aug 13, 2007 10:32:20 PM


Isn't backdating and intent-to-defraud somewhat of an oxymoron? What other purpose would there be, when it ties in with a distinct crime?

Posted by: Jack Payne | Aug 9, 2007 10:39:14 PM

Nah its not an oxymoron. Backdated options are used because they are better than hiring bonuses to capture key employees. Backdated options effectively give the employee a hiring bonus, but he can't collect it for 4 years and only then, if the company share price is above the grant. The term for this is "in the money". The employee typically will never leave if he is in the money and cannot take the benefit for 4 years. This is the reason backdated hiring bonuses are implemented and *not* a means of defrauding investors, typically. Of course it would have been nice if one of the companies engaged in this like Microsoft stood up and came clean in the heady days of the 90s but they did not, which then meant there was no call to change the shaky disclosure process for any of the smaller companies like Brocade. that is the issue here.

Posted by: DM | Sep 14, 2007 11:18:17 AM

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