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The stock-options backdating scandal has produced 16 criminal prosecutions, the disclosure that 220 companies have been subject to internal or federal investigations and 100 corporate earnings restatements totaling $12.4 billion. It has also produced some very nervous white-collar criminal defense lawyers because backdating leaves wide open questions for the end game � what to advise clients who may face a potential jail sentence if convicted. “The first question a client asks is: What happens if I’m convicted?,” said Peter Henning, a professor at Wayne State University Law School in Detroit who teaches about white-collar crime. “If you say it could be probation or 10 years, that’s not helpful. Lawyers are flying blind and lawyers hate that.” Two key battles loom for sentencing. First, which sentencing guidelines apply: the pre-Enron guidelines or the post-Enron version in November 2001 that ratcheted up sentences for corrupt executives? Second, given that the bigger the financial losses for investors the longer the prison term, how should one calculate losses that are critical to sentencing? No one knows for sure how to calculate losses that may amount to bookkeeping changes, not cold cash. “There is no precedent for this,” said Charles A. Ross of New York’s Ross & Associates, defense counsel in the Monster Worldwide Inc. case. “There is a smorgasbord of risk out there,” he said. Reyes the key In three sentencings so far, William Sorin, former general counsel to Comverse Technology Inc., was sentenced in November to one year and a day in prison based on a guilty plea to conspiracy to commit fraud. U.S. v. Sorin, No. CR06-723NGG. On Aug. 2, Ryan Brant, founder of Take-Two Interactive Software Inc., was given probation in a state court case where federal guidelines were not an issue. Take-Two accounting chief Patti Tay also received probation. Among those criminally charged, seven await trials, seven have entered guilty pleas and one, Jacob “Kobi” Alexander of Comverse, has fled to Namibia. Former Brocade Communications Inc. CEO Gregory Reyes, the only executive to face a jury, was convicted on all 10 counts earlier this month. U.S. v. Reyes, No. CR06-556CRB. It is the Reyes sentencing, scheduled for November, that is likely to set the standard in backdating cases. “Reyes will give us the road map,” Henning said. Neither Reyes’ defense attorney, Richard Marmaro of Skadden, Arps, Slate, Meagher & Flom’s Los Angeles office, or Assistant U.S. Attorney Timothy Crudo would comment on their sentencing strategies. Even defense lawyers disagree about how to apply sentencing rules in this uncharted territory. “There has never been a loss calculation applied to options backdating,” said Melinda Haag of Orrick, Herrington & Sutcliffe’s San Francisco office. She represents Lisa Berry, under investigation for her handling of options backdating while general counsel of KLA-Tencor Corp. and later Juniper Networks Inc. Calculating loss for purposes of sentencing “will be a battle of experts,” Haag said. “They will all have opinions about what a loss means, but I don’t think, as we sit here today, anyone knows.” Henning suggested that judges might rely on the corporate restatements of earnings as a benchmark of losses. But the restatement of hundreds of millions in losses can add five years to a prison sentence. Brocade, for example, restated earnings to show $100 million in noncash expense attributed to options backdating. “The nice thing about use of restatement numbers, they are calculated by an accountant and reported in a public filing,” he said. But they are noncash charges and may not represent lowered income, he added. Stock-options backdating is not illegal. It is the failure to properly account for backdating as an expense to the company that got so many in trouble. Some have suggested that any temporary drop in stock price after backdating was disclosed should count as a loss to shareholders for purposes of sentencing. But too many other market factors could have caused a stock price drop to make that a fair calculation, according to Lawrence Iason of Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer in New York. He represented Brand in the Take-Two case. And U.S. District Judge Charles Breyer, who will sentence Reyes in November, has signaled his unwillingness to use a single stock price drop event to calculate losses for sentencing purposes in a 2003 fraud case. He settled on the average stock price for 60 days during the fraud and the 60-day average after the fraud to show the loss. U.S. v. Grabske, 260 F. Supp. 2d 866. Breyer’s Grabske ruling was cited favorably by the 5th Circuit when it ordered reduction of the 24-year sentence of former Dynegy Inc. executive Jamie Olis. U.S. v. Olis, 429 F.3d 540 (2005). Others have said the most logical calculation would be the difference between the backdated price and what the price should have been, then factoring in the number of options actually exercised to purchase stock shares. “That makes more sense,” said Leslie Caldwell, co-chairwoman of white-collar defense at Morgan, Lewis & Bockius from its New York office and former head of the Justice Department’s Enron prosecution team. Stock price drops are inappropriate for backdating cases because it would be hard to show backdating affected investor decisions. Restatement numbers are too big, she said. “Those are losses on paper, not real losses,” said Caldwell, who represents Myron Olesnyckyj, former general counsel of Monster Worldwide. He pleaded guilty to conspiracy and fraud. He will be sentenced at the end of the month. It is the Enron debacle that formed “the great divide” in sentencing guidelines, according to Henning. After Enron, the November 2001 sentencing guidelines changed, substantially increasing the prison term for economic crimes. Henning said, “The judge must decide when the primary [illegal] conduct occurred” to select the guidelines that apply. By contrast, Haag said if the conduct spans multiple editions of the guidelines, the version most favorable to the defendant has traditionally applied, based on constitutional ex post facto concerns. Justice Department spokeswoman Jaclyn Lesch said that “because of ex post facto concerns, many times the individual is sentenced to the guidelines that were in place at the time of the crime,” meaning ones beneficial to the defendant.

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