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CEO's conviction in landmark stock options case is overturned

Gregory Reyes of Brocade Communications Systems was the first chief found guilty by a jury of backdating grants. He will face a retrial after a judge's finding of prosecutorial misconduct.

August 19, 2009|Tom Petruno

In a blow to the government, the first chief executive found guilty by a jury of backdating stock option grants has had his conviction overturned.

Gregory Reyes, former CEO of Brocade Communications Systems Inc. of San Jose, will get a new trial after a federal appeals court in San Francisco ruled that his case was tainted by prosecutorial misconduct.

Reyes, 46, was convicted in 2007 of conspiracy and fraud for backdating employee option grants in 2001 and 2002. The practice, widespread particularly in the technology industry, was a way to cherry-pick favorable exercise prices for the options, boosting their value to employees.

But backdating also had the effect of understating corporate expenses, and prosecutors said it amounted to fraud because shareholders weren't told of the practice. Brocade and many other companies had to restate previous earnings reports to properly account for option expenses.

The government saw the Reyes trial as a showcase that would send a strong message to other executives.

Reyes was sentenced to 21 months in prison and assessed a $15-million fine. But he has been free since his trial, pending his appeal.

The appeals court did not dispute that the government met the burden of showing that Reyes' backdating of options falsified records and thus withheld information that investors should have been given.

But in overturning the conviction, the court noted that Reyes had argued that "he relied in good faith on the accuracy of the [Brocade] finance department's documentation when he signed off on false financial statements. . . . . Reyes' counsel . . . therefore told the jury that the finance department knew about the backdating, thus supporting the defense position."

Yet one of the government's prosecutors, the court said, "told the jury that the employees in the finance department 'don't have any idea' that the backdating was occurring. The prosecutor thereby asserted to the jury facts that he knew were belied by the statements to the FBI from responsible finance department officers."

"In representing the United States, a federal prosecutor has a special duty not to impede the truth," the court said in its decision.

The appeals panel also affirmed the backdating-related conviction of Stephanie Jensen, Brocade's former human resource director, but ordered a new sentencing.

Among the highest-profile backdating cases still pending: Former KB Home CEO Bruce Karatz, 63, is facing trial in Los Angeles on charges that he backdated options for himself and other executives, defrauding shareholders.

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tom.petruno@latimes.com

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