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U.S. District Judge Charles Breyer slapped down Brocade ex-CEO Gregory Reyes’ argument Friday that Securities and Exchange Commission charges should be tossed because investors were not materially harmed by earnings restatements resulting from stock-option backdating. “If this is so irrelevant, why was there all this backdating going on?” Breyer asked. The judge also rejected an argument put forth by Reyes’ lawyers at Skadden, Arps, Slate, Meagher & Flom � led by partner Richard Marmaro � that the Department of Justice had unfairly changed the thrust of its arguments in the parallel criminal case. The government in both cases alleges Reyes and former Brocade human resources officer Stephanie Jensen committed fraud by backdating options and failing to properly record them as an expense. The DOJ and SEC say the information Reyes and Jensen were concealing from the public was material, or significant enough to give investors pause. Attorneys for the defense argued that stock-option expenses didn’t matter “a whit” to shareholders, and accused the DOJ of taking a different tack with its arguments. Defense lawyers say the government first accused their clients of disobeying one accounting standard, but when prosecutors realized they couldn’t prove materiality under that theory, changed their approach and accused the executives of violating a different standard. Deciding first on the question of whether the DOJ changed its arguments mid-stream, Breyer said it was perfectly within their right to do so. “You can’t change crimes [that are alleged],” Breyer said. “I understand that. That’s not what’s going on here.” A judge can’t throw out an indictment because the government has altered how it plans to prove the crimes occurred, he said. On the materiality issue, Skadden partner Christopher Gunther argued Friday that the Jan. 24, 2005, $200 million-plus restatement � which resulted when Brocade acknowledged and properly accounted for backdated options � caused no material effects for the investing public. Investors “yawned,” Gunther said. The stock price two days later was the same as just before the announcement, he said. But SEC attorney Susan La Marca pointed out that on Jan. 6 of that year, when the company announced that a restatement would be coming, the stock fell by 7 percent. “Wasn’t this a warning shot over the bow that something was wrong with the accounting at Brocade?” Breyer said to Gunther. The case has been closely watched by the white-collar bar, given that numerous executives are currently facing SEC charges and/or DOJ charges in connection with backdating. Reyes was the first executive to be criminally charged. Outside court, La Marca said each backdating case has a different fact pattern, and therefore it was hard to say whether Breyer’s decision on the materiality argument will have an effect on other cases. But, in general, “if you have a giant number of backdated options, it’s certainly material to investors,” she said. “They care.” Marmaro declined to comment, other than to say his team was “obviously disappointed” with the day’s results. University of Denver law professor Jay Brown, a former SEC attorney, said that while Reyes’ materiality argument was clever, other courts have found that the stock price does not have to decline for material harm to be caused investors. “Just because there was no market movement doesn’t mean it wasn’t material,” Brown said. But the question of the extent of injury to investors is an important one, he said. “With at least some of these backdating cases, you have allegations of just fraud and manipulation, but in what turns out to be relatively small dollar amounts.” Most fraud cases, he said, do have a material effect on share prices, while at companies that backdated that has not always been the case. A judge who dismissed a case based on Reyes’ argument would “effectively be saying you can backdate and commit fraud” so long as it doesn’t involve a lot of money. Jury selection in the criminal case against Reyes and Jensen is set to begin June 11.

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