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The first executive to be convicted by a jury of options backdating is not likely to spend nearly as much time in prison as the government hoped. In the first indication of how much prison time former Brocade Communications Systems Inc. executive Gregory Reyes faces, U.S. District Judge Charles Breyer rejected the government’s desire for as much as 24 to 30 years in prison, in a pre-sentencing order issued on Friday. Instead Breyer indicated he would base the sentence on a sentencing guideline range of 15 months to 21 months in prison. Breyer’s rulings on loss calculation from stock prices could also be a boost to the executives still facing criminal charges, U.S. v. Reyes, CR06-556CRB. Breyer rejected many of the government’s requested sentence enhancements, including a $2.5 billion to $3 billion shareholder loss estimate using the rescissory loss method, which basically calculates the loss by the difference between the average price of the stock during the four-year fraud period and the share price after the fraud was disclosed. The difference is then multiplied by the number of shares. It is “not possible to untangle the effect of Reyes’ conduct from the substantial effect that external factors — such as market and industry conditions — had on Brocade stock price,” Breyer wrote. He also declined to attribute to Reyes fraud the one-day stock price drop of 52-cents a share in 2005. Nor would the judge use the amount of fines and tax obligations assumed by the company as an indication of the size of the fraud. The government also failed to show by clear and convincing evidence that Reyes personally benefits from any back-dated options, so Breyer would not attribute $5 million in personal gain to Reyes for sentence enhancement. Even showing that more than 250 shareholders were “victims” of the backdating fraud was not applied because the sentencing guideline definition of “victim” was narrow and could not be applied. With Reyes indicating that Brocade has indemnified him from potential cost of any criminal fine, Breyer asked for additional briefing on the question of whether it is possble for a company to indemnify anyone from a fine for unlawful conduct. A federal jury convicted Reyes in August of conspiracy, securities fraud and filing false statements with the Securities and Exchange Commission for backdating stock option grants to Brocade employees. A second jury convicted Stephanie Jensen, the company’s former vice president of human resources in a separate trial in December. Brocade is the largest maker of switches for data-storage networks. Options allow the holders to buy stock shares at a later date, but at the trading price on the day the options were granted. By backdating, many companies retroactively give employees options at stock prices lower than the price on the actual day the options issue, known as in-the-money options, it creates built-in profits. It is not illegal unless the backdating goes undisclosed and unrecorded as a company expense from shareholders and regulators. As many as 200 companies have indicated there are internal or federal investigations of options backdating.

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