Brocade backdating scandal turns criminal

The criminal charges filed Thursday against former executives of Brocade Communications Systems Inc. may be a harbinger of more indictments to come in an options backdating scandal that has already cast a shadow over many high-tech companies.

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The U.S. Attorney's Office for the Northern District of California charged former Chairman, President and Chief Executive Officer Gregory Reyes and former Vice President of Human Resources Stephanie Jensen with securities fraud. It also filed a civil complaint charging fraud and other securities violations, which names former Chief Financial Officer Antonio Canova as well as Reyes and Jensen.

Brocade, a storage networking company in San Jose, California, was founded in the late 1990s and granted stock options to new employees, a common practice in the red-hot Silicon Valley job market of the time. The company has already restated results from the years 1999 through 2004 due to accounting issues related to options grants.

Several major high-tech companies are undergoing independent and SEC (Securities and Exchange Commission) investigations regarding options. Apple Computer Inc., McAfee Inc., Broadcom Corp., Sycamore Networks Inc. and Rambus Inc., recently have grappled with the issue.

Brocade's case is ahead of the pack in reaching the criminal stage, but it's unlikely to be the only company where executives are accused of crimes in this area, according to one observer.

"The stove's been turned up," said Brian Foley, a lawyer and independent compensation consultant in White Plains, New York. "One gets the sense that there's going to be more, probably considerably more, (criminal indictments) at other companies." That may take a while because many other cases are fairly new, he added.

The same U.S. Attorney's Office that charged the Brocade executives said last week it has formed a special task force with the FBI (Federal Bureau of Investigation) to investigate companies in Northern California that may have deliberately backdated option grants with intent to defraud.

Reyes and Jensen orchestrated stock option grants with exercise prices below the price of Brocades' stock on the day of the grant, according to the U.S. Attorney's Office. This type of grant could give the employee an immediate gain, on paper, and was not illegal. But the Brocade executives allegedly made those grants look like another type in which the exercise price is the same as the stock price on the day of the offer. That move let them conceal millions of dollars of expenses from investors, the government said. It alleges that Reyes set earlier grant dates and Jensen falsified documents to make it appear the options had been granted on the earlier date.

The civil complaint accuses Canova of knowing the crimes had taken place, not advising the company's auditors and Audit Committee, and signing false and misleading financial statements.

Brocade said Thursday it had no comment on its former employees.