Ex-Brocade CEO Convicted in Backdating Scandal

Former Brocade Communications Systems CEO Gregory L. Reyes was convicted Tuesday of defrauding investors by improperly disclosing the backdating of stock options and filing false financial statements during his seven-year rein atop the storage networking firm.

A San Francisco jury found Reyes guilty on all 10 felony counts brought against him, including securities fraud, conspiracy and filing false financial statements. He’s scheduled to appear before U.S. District Judge Charles Breyer on Nov. 21 where he could be sentenced to 10 years or more in prison.

Reyes’ conviction marks the first time an executive has been convicted as part of the Justice Department’s crackdown on the improper disclosure and accounting for the backdating of employee stock options. Backdating refers to the practice of selecting favorable dates in the past when a company’s stock price was low and awarding option grants for those dates, increasing the potential value of the options when the company’s stock appreciates. Backdating isn’t illegal, but failing to disclose or properly account for the practice in financial statements constitutes felony securities fraud.

Federally mandated accounting standards such as Sarbanes-Oxley , a direct result of the accounting scandals at Enron and WorldCom, weren’t in place during the years in which the vast majority of companies were improperly backdating options.

“Under SOX, it would not be possible for [Reyes] to have backdated the options as he did,” John Carney, a partner at the Cleveland, Ohio-based firm Baker Hostetler, wrote in an e-mail to internetnews.com. “While robust corporate compliance and internal auditing programs seem like a chore to some CEOs, they would have made it hard, if not impossible, for [Reyes] to get away with the practice…deterring him and ultimately saving his skin.”

Brocade  is just one of more than 200 companies that have publicly disclosed either internal or federal probes into their option-dating practices. Reyes’ conviction will surely capture the attention of current and former technology executives who managed their companies throughout the dotcom heyday and long before Sarbanes-Oxley compliance rules were mandated.

Reyes’ conviction could also give federal prosecutors additional confidence to prosecute high-profile executives at other companies that have admitted to improperly disclosing or accounting for option grants. In October, Apple released a report of its own backdating investigation, confirming that CEO Steve Jobs was aware of the practice in “a few instances.”

“This verdict could make indictments, even in borderline cases, much more likely,” Carney added.

Reyes, 44, was indicted almost a year ago along with Brocade’s former vice president of human resources, Stephanie Jensen. Jensen is still awaiting trial. In May, the Securities and Exchange Commission settled its stock-option backdating case with Brocade, forcing the company to pay a $7 million fine without admitting or denying any of the allegations.

Leslie Davis, a spokeswoman for Brocade, told internetnews.com the company “respectfully declines to comment” on Reyes’ conviction adding that it was moving on and “focusing on the business at hand.”

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