Is Greg Reyes, the former Brocade Communications Chief Executive, guilty of fraud for backdating stock options if investors didn’t care? That seemed to be the big question for the 9th U.S. Circuit Court of Appeals during today’s argument.
The court better hurry. Reyes is already halfway through his prison term. (He was also ordered to pay a $15 million fine.)
Reyes’ hopes for salvation from the 9th Circuit have worked in the past. Two years ago the court overturned his 2007 conviction based on allegations of prosecutor misconduct. Prosecutors were accused of misstatements about evidence in closing arguments. A second trial resulted in another conviction. The difference is sentences? His original 21-month term was cut to 18-months after the second go-round.
Reyes’ lawyer is no less than Seth Waxman, the former U.S. Solicitor General under President Clinton. Waxman says federal prosecutors couldn’t find investors who cared about the backdating even after putting an ad in the Wall Street Journal asking for some.
“You’re saying this is a failure of proof?” asked Judge Milan Smith to a packed courtroom.
Waxman: “Yes. The government has to prove… has to come up with someone, an investor or expert, who says I care about this and it matters.”
But Smith was also doing some math. During the five-year period the backdated options were an issue, company earnings would have been reduced $950 million, cutting into profits and in some years adding to losses, Waxman acknowledged.
In 2003 earnings show a net loss of $136 million. “You’re talking about a significant impact on the company,” said Smith.
The Government’s lawyer, Amber Rosen, replied to Smith’s question of whether prosecutor’s failed to prove their case, “absolutely not.”
She said two government witnesses who advised institutional investors testified that they believed the failure of Brocade to disclose the option expenses was significant to investors and thus material to the question of guilt.
“Gross overstatement of earnings in itself is material,” she said.
Waxman also argued that the prosecutors committed misconduct by telling jurors to ignore certain evidence. That worked to overturn his first conviction.
Reyes was found guilty at a second trial in 2010 of securities fraud and other charges based on the accounting shenanigans that roiled Silicon Valley when a number of firms backdated stock options to get the best share prices and failed to report the cost of options to shareholders.
Reyes was the first chief executive convicted by a jury for options backdating after the government began a crackdown on the practice.
The allegations were that backdating the stock grants to employees inflated company shares because the options costs weren’t reported to shareholders.
The prosecutors said Reyes personally profited by at least $37 million stock sales during the period Brocade’s shares were artificially high.
The three-judge panel includes Judges Ronald Gould, appointed by President Bill Clinton; Smith, appointed by President George W. Bush and Algenon Marbley, a visiting judge from Ohio, also appointed by Clinton.
Case: U.S. v. Reyes, No. 10-10323