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The initial casualties of the government’s massive stock option backdating probe had their first chance to try to get their cases thrown out of court on Wednesday. But after an hour of arguments, it seemed unlikely that U.S. District Judge Charles Breyer would dismiss some of the fraud counts against former Brocade Communications CEO Gregory Reyes and ex-HR manager Stephanie Jensen. The motion to dismiss seven criminal counts is part of a two-pronged effort � made possible by Breyer’s insistence that criminal and civil government cases proceed together � to gut criminal and civil SEC charges accusing the defendants of backdating employee stock options to recruit and retain top talent during the dot-com boom. The other prong, a motion for summary judgment on the civil side, was filed late Monday. At Wednesday’s hearing, a lawyer for Reyes � Skadden, Arps, Slate, Meagher & Flom partner Christopher Gunther � argued that an August decision by the Fifth Circuit U.S. Court of Appeals should invalidate seven counts in the indictment. Reyes is indicted on 12 counts and Jensen on eight. Gunther’s energetic presentation included a chalkboard drawing and a stroll across the courtroom to display how far “out on a limb” prosecutors were going with their case. The opinion he cited, U.S. v. Brown, 2006 WL 2130525, found that a person cannot be convicted on charges of denial of honest services if he or she was acting in the best interests of the company. And, Gunther said, the government’s indictment says that Reyes and Jensen manipulated options grants not for their own gain, but to benefit the company. “This is a case that’s got no victim, and it’s got no ill-gotten gains,” he said. Breyer seemed interested in the Brown arguments and asked the prosecutor, Assistant U.S. Attorney Christopher Steskal, whether the Department of Justice had decided how to deal with the case’s fallout. “Right now, the only policy I’m aware of, your honor, is that Brown was wrongly decided,” Steskal said. He also told the judge that it’s possible that later in the case, when the government produces its evidence, it could offer support for behavior that would involve self-dealing.
‘For securities fraud to exist, there must be fraud. For “fraud,” there must be a victim and a materially false statement. Here, there is neither.’


In the end, Breyer seemed inclined not to dismiss the indictments � at least not right away � since the honest services issues could be revisited later in the case. But even if the judge doesn’t dismiss the criminal counts, the defendants are holding out hope that a collateral motion could make that moot. In their summary judgment arguments in the SEC’s civil case against Brocade, Reyes’ lead lawyer, Skadden partner Richard Marmaro, argues that none of the alleged wrongdoing at Brocade resulted in material damage to the company. Since most of the backdated options were never exercised, the expenses they incurred, Marmaro said, were predominantly limited to paper, and didn’t extend to the company’s cash flow. And therefore, he argues, there was no damage to the company.
Optional Reading

Read The Recorder‘s roundup of the stock-option backdating scandal. There won’t be a test later … but there might be a subpoena.

“For securities fraud to exist, there must be fraud,” Marmaro wrote. “For ‘fraud,’ there must be a victim and a materially false statement. Here, there is neither.” The motion included hundreds of pages of financial analyses, news stories and formerly privileged internal company documents relating to the expense issue. After the hearing Wednesday, Marmaro argued that if the summary judgment motion is successful � and Breyer rules in the civil case that there was no material damage to the company � the judge would have to reconsider whether the criminal case should move ahead. “Who was the victim of this conduct?” Marmaro asked.

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