Former Brocade Communications Systems, Inc. CEO Gregory Reyes and Stephanie Jensen, former VP for human resources at the company, were charged in a criminal complaint with securities fraud in the first prosecution arising from the many stock options-timing investigations.  The SEC filed a civil securities fraud action (complaint here) against Reyes, Jensen, and Antonio Canova, Brocade’s former CFO, who was accused of not reporting the backdating of options to the company’s board or audit committee.  A press release issued by the U.S. Attorney’s Office for the Northern District of California (here) describing the alleged securities fraud:

According to the criminal complaint and the Commission’s civil
complaint, Reyes, 43, of Saratoga, Calif., and Jensen, 48, of Los Altos,
Calif., regularly caused Brocade to
grant “in-the-money” options (i.e., the exercise price is below the stock’s
market price on the day of grant, giving the recipient an immediate paper gain)
to both new and current employees between 2000 and 2004, but backdated
documents to make it appear that the options were “at-the-money” (i.e., the
exercise price is the same as the stock’s market price on the day of the grant)
when granted, thus concealing millions of dollars in expenses from
investors.  Under well-settled accounting principles applicable at the
time, options granted “at-the-money” did not need to be expensed.  In
contrast, options granted “in-the-money” needed to be recorded as a
compensation expense. 

The separate criminal and civil complaints allege that Reyes repeatedly
used hindsight to select a date with a lower stock price from the recent past
as the supposed option grant date.  To facilitate the scheme, Jensen
created, or directed others to create, paperwork making it appear that the
options had been granted on the earlier date.  In some instances,
employment offer letters and compensation committee minutes were falsified and
purported to document option grants to employees before they had even been
hired by the company.  As a result of this practice, Brocade was able to
give employees “in-the-money” stock options without having to recognize
compensation expenses as required by accounting rules.  When these stock
option abuses surfaced, Brocade was required to restate and revise its
financial statements for fiscal years 1999 through 2004.

It’s not clear why prosecutors chose to proceed by criminal complaint rather than seeking a grand jury indictment.  Usually, criminal complaints are used in cases in which a defendant will plead guilty to the charge, so it may be that Jensen has a plea agreement and Reyes will be indicted in the near future.  It also could be that there was a looming statute of limitations problem for some of the options grants so charges had to be filed immediately.  If neither defendant agrees to a plea, then we should expect to see a grand jury return an indictment in the next few weeks that may well contain more charges, perhaps including books-and-records accusations. 

The Wall Street Journal Law Blog (here) quotes Reyes’s attorney, Richard Marmaro, stating: "Greg Reyes is innocent, and if necessary, we will prove his innocence
in a court of law. Financial gain is always the motive in securities
fraud cases, and here there was none. There is not even an allegation
of self-enrichment, or self-dealing. Nor is there any evidence of an
intent to misstate the financial statements of the company."  While the charges allege numerous instances of options grants involving backdated documents, it remains unclear what constitutes the securities fraud.  As Marmaro asserts, Reyes did not gain from the transactions, and while Brocade certainly lost quite a bit of money because of the tax consequences of the backdating practices, it is not clear what constituted the fraudulent scheme when the employees received the proper amount of options while their additional paper gains were not "taken" from the company.  To the extent that fraud is a type of larceny, it is not easy to see the company as the victim of a deception, and Reyes did not gain from the transactions, at least not directly.  Not all lies are frauds, and the government’s case may be a difficult one, at least on a securities fraud charge. (ph)