In announcing criminal and civil complaints against the former CEO and HR manager of Brocade Communications Systems Thursday, the San Francisco U.S. attorney and Securities and Exchange Commission painted the stock option backdating issue in tones of black and white.
“In many cases it makes a hash of a company’s financial statements,” said SEC Chairman Christopher Cox, in from Washington to trumpet the first charges in a probe that’s hit about 80 companies, many in Silicon Valley. “It’s poisonous.”
“We are looking strongly, intently and aggressively at similar issues,” added U.S. Attorney Kevin Ryan.
But despite Cox’s harsh language before an armada of reporters, those ongoing regulatory and criminal investigations are moving into an area more gray than black.
Indeed, even as Cox and Ryan excoriated Brocade’s former CEO, Gregory Reyes, and former vice president of HR, Stephanie Jensen � along with former CFO Antonio Canova, who only faces civil charges � lawyers and accountants for the government, companies and executives are attempting to figure out how to separate the truly criminal conduct from less nefarious errors in dating options grants.
And so earlier this week, SEC Acting Chief Accountant Scott Taub met with representatives of the Big Four accounting firms in Washington, according to several private lawyers with backdating clients. They discussed what circumstances would necessitate measures like major restatements of earnings, and which situations federal authorities would view as less egregious.
“There’s nothing on that topic that I care to comment on,” Taub said Thursday.
White-collar defense lawyers have cheered the dialogue, saying it will impose a measure of stability as they try to figure out the extent of their clients’ exposure.
“People have been trying to make those kinds of judgments,” said an in-house lawyer for a Big Four accounting firm, “and set up discussions so there is a constant flow of information.”
Outside accounting firms are responsible for evaluating the impact of backdating on a company’s finances � and for determining which companies will have to restate earnings, and to what extent.
Such restatements are key pieces of government investigations. So defense lawyers say guidance on the issue from the SEC will lend some clarity to just how serious a given company’s problems are.
“It would presumably create some situation, a safe harbor,” said a defense lawyer who spoke on the condition that he not be identified because he represents multiple subjects of backdating probes. “It would be something that would create some stability.”
The defense lawyer, like several others, said that with the exception of the most egregious cases, backdating was just how business was done in the Valley during the dot-com boom. In addition, they said, many date changes were the result of clerical errors.
In some instances, defense lawyers said, companies may have used the date the employee was notified of the grant.
Strictly speaking, the official date of the grant should have been the day the last required signature � known as “unanimous written consent” � was obtained, though that may have taken weeks or months.
Read The Recorder‘s roundup of the stock-option backdating scandal. There won’t be a test later … but there might be a subpoena.
Defense lawyers say the SEC’s view of that practice will have a major impact on the backdating investigations.
Another defense lawyer who asked not to be identified due to client sensitivities said that could be the single most important product of SEC/Big Four discussions.
“The very conservative accounting view of a unanimous written consent is that a grant isn’t valid until the very last signature,” the lawyer said. “It’s unpractical to handle it that way.”
A more charitable view of business as usual in the Valley would hearten defense lawyers. “If the meeting between the SEC and the Big Four firms results in the Big Four accounting firms being more practical about their judgment, that could be very helpful,” the lawyer said.
But that concern means little to Richard Marmaro, the Skadden, Arps, Slate, Meagher & Flom partner representing Reyes. He said Thursday his client is facing an unfair lot.
According to government prosecutors, in an effort to compete in the high-intensity Silicon Valley job market, Brocade egregiously backdated options as a way of trying to attract employees.
The criminal complaint says Reyes and Jensen “intentionally devised, and intended to devise, a scheme and artifice to defraud Brocade, its Board, its shareholders, its auditors, the public, and the SEC as to a material matter.”
But Marmaro disagrees � he says the government has no proof of his client’s intent and doesn’t even allege that Reyes made money off the alleged backdating.
“They’ve got the wrong guy. There’s no evidence of self-enrichment,” Marmaro said. “He never granted himself options.”
He said that “there were some paper problems in the company’s HR department” that resulted in backdating but that it didn’t amount to criminal conduct.
“We’re planning to move to dismiss the complaint,” he said. “There’s no evidence in this case.”
But Linda Thomsen, the chief of enforcement at the SEC, told reporters Thursday that it doesn’t matter that Reyes didn’t cash in himself: Executives still face liability because the backdating concealed corporate expenses, and that may have affected stock prices.
At the press conference, one reporter raised a figure of considerable recent interest in Brocade: Larry Sonsini, the chief rainmaker at Wilson Sonsini Goodrich & Rosati, a firm that has represented at least half the 32 Silicon Valley companies under investigation at one time.
In an interview with Business Week magazine earlier this year, Reyes blamed Sonsini � who was a member of Brocade’s board � for suggesting an options-grant program that let the CEO act as a “committee of one” to grant options. Ryan wouldn’t comment on Sonsini or other board members.
But Marmaro was adamant that his client’s statements aren’t an attempt to blame the attorney for wrongdoing. Instead, he said Sonsini recommended a perfectly appropriate system.
“Larry Sonsini and the board of directors gave Greg Reyes full authority to price options as he saw fit,” Marmaro said. “And Larry Sonsini is an honest, ethical man.”