Tuesday, January 15, 2008
Former Brocade Communications CEO Gregory Reyes will be sentenced by U.S. District Court Judge Charles Breyer on January16 for his role in backdating options at the company. There are the usual Federal Sentencing Guidelines issues in the case, including the government's request for an obstruction of justice enhancement based on Reyes' affidavit in support of a severance motion filed by his co-defendant, Brocade's former human resources manager, who was also convicted in a separate trial. The argument is pretty thin for the enhancement, and I doubt Judge Breyer will buy it. Under the now-advisory Guidelines, the Probation Office appears to have recommended an Offense Level of 15, comprised of a base offense level of 7 plus two four-level enhancements for leadership role and Reyes' position as CEO of a publicly-traded company at the time of the offense. That would put the sentencing range at 18-24 months. Reyes' sentencing memorandum (available below) argues for a below-Guidelines sentence on a variety of grounds, including extraordinary family circumstances that are redacted from his filing and the fact that Judge Breyer earlier determined there was no calculable loss from the violations (see earlier post here). His attorneys have asked for a below-Guidelines sentence, recommending a short period of confinement in a half-way house and then home detention along with a term of community service, including a proposed project with the Boys & Girls Club. The government recommends a sentence of 30-33 months, based on adding in sentencing enhancements for sophisticated means, which Judge Breyer earlier rejected, and obstruction. The Probation Office also recommends a fine of over $17 million, which prosecutors want bumped up to over $40 million; not surprisingly, Reyes' counsel argues for no fine. I suspect Judge Breyer will impose a substantial fine, given Reyes' economic means, and go to the low end of the Guidelines at a minimum. It would not surprise me if he imposed a below-Guidelines sentence, perhaps a split term with a period in an FCI and then home confinement -- the ol' double-nickel (five in and five on the house).
The most interesting argument by the government is not on the sentencing but a proposal that Judge Breyer require Reyes to repay most of the cost of the attorney's fees Brocade has incurred for its employees, including Reyes, under indemnification agreements and its corporate by-laws. As detailed in a letter from the company's counsel, Cooley Godward (available below), Brocade has paid over $64 million to date in attorney's fees from the criminal and SEC cases, along with shareholder derivative lawsuits spawned by the backdating. The largest amount of attorney's fees is for Reyes, at $46.7 million, with another $7.1 million for his co-defendant in the criminal case, $3.7 million for a co-defendant in the SEC case, and the rest for various officers and directors caught up in the investigation. The government asserts that Reyes should be liable for at least $57 million of the attorney's fees.
The government's argument for restitution is that Brocade would not have suffered these costs if Reyes had not backdated the options, and that the corporation is the victim of his offenses. The government also argues that Reyes should pay the $28 million it has cost Brocade for the internal investigations and defending itself in the various cases, the $7 million fine paid to settle the SEC action, and the $3.3 million paid for taxes for its employees whose options were backdated in violation of certain IRC provisions.
The Victims and Witnesses Protection Act (VWPA) provides that the court "“shall order restitution to each victim in the full amount of each victim’s losses as determined by the court . . . ." 18 U.S.C. Sec. 3664(f)(1)(A). Are attorney's fees paid by a corporation pursuant to a contractual agreement or corporate by-law a "loss" that is subject to the VWPA, particularly for costs incurred by other officers and directors in the course of the investigation? As first blush, the term "loss" usually is understood to mean the amount directly attributable to the crime and not consequential damages, but that term does not necessarily preclude including the effects of one's crime on a corporate enterprise. The problem with the government's argument is that the company agreed to pay the defense costs regardless of whether Reyes committed a criminal act. The indemnification agreement (available below) is a broad contractual arrangement that is not conditioned on an officer avoiding a criminal conviction, and the company can even commit to paying a fine on behalf of an officer or director. Brocade made the agreements with its people as a matter of its own choice, and it seems contradictory to say that it can now recover costs from Reyes through the VWPA that it would not get back under the contract.
Indemnification agreements are common in the corporate world, and indeed I doubt any publicly-traded corporation does not have provisions similar to Brocade's in its by-laws. While the payment of attorney's fees for an officer convicted of a crime while acting on the company's behalf seems incongruous -- why should the company pay for the lawyer of an officer who engaged in misconduct on the company's time -- as a matter of corporate and contract law broad indemnification agreements are fully accepted (and enforced) by courts, particularly the Delaware courts that handle so many corporate cases. I doubt Judge Breyer will order Reyes to repay the attorney's fees, leaving it to Brocade to try to get them back under its contract, if that's possible, rather than using the VWPA as a back-door means of negating indemnification.
The government's disclosure does give us a rare inside look at the cost of paying for lawyers for various corporate officials caught up in a large-scale investigation. Needless to say, the amounts are significant, and I would not be surprised if the final tally for the legal fees hits $100 million when you include the charges for counsel to the board and in the internal investigations. We can add Reyes' $46 million in fees to the list of totals in corporate prosecutions, such as the estimated $75 million spent by Jeffrey Skilling. And that total continues to grow, because the appellate process will add to the cost of defending Reyes. (ph)