Charges Filed in Options Probe

By Carrie Johnson
Washington Post Staff Writer
Friday, July 21, 2006

Federal prosecutors yesterday filed the first criminal charges against a top executive who allegedly manipulated stock option awards in order to give his employees a bigger payday and conceal corporate expenses.

The U.S. attorney's office in San Francisco, which a week ago formed a task force to probe corporate backdating of stock-option grants, in a criminal complaint accused former Brocade Communications Systems Inc. chief executive Gregory L. Reyes and former human resources executive Stephanie Jensen of securities fraud.

A grand jury has not yet indicted Reyes or Jensen, who denied wrongdoing yesterday through their attorneys. Both are to appear before Magistrate Judge Joseph C. Spero on Aug. 2. Each could face as many as 20 years in prison and a $5 million fine if convicted, U.S. Attorney Kevin V. Ryan said.

In a related action, the Securities and Exchange Commission charged Reyes, Jensen and former finance chief Antonio Canova with civil violations of securities laws. Authorities say that Reyes presided over the scheme at the San Jose computer networking company, that Jensen directed others to falsify employment paperwork and board minutes, and that Canova failed to blow the whistle after receiving written warnings about the issue.

The charges amount to a significant advance in a large and spreading scandal. Since the issue became public this year, more than 60 publicly traded companies, including Apple Computer Inc., Intuit Inc. and UnitedHealth Group Inc., have announced internal investigations or regulatory probes into their stock-option practices.

Stock options give workers an opportunity to purchase shares at a specific price in a set time frame. Employees profit from the difference between the stock price on the day the options are awarded and the price on the day they are sold. Options became an important recruiting tool in the 1990s, particularly for young companies seeking to attract top-notch talent in a competitive labor market.

An academic study released last week suggested that more than 29 percent of businesses may have tampered with stock grants from 1996 to 2005. Its authors, Indiana University professor Randall A. Heron and University of Iowa professor Erik Lie, reported that they had uncovered a "higher frequency" of problems among technology companies, small businesses and ventures with volatile stock prices.

At a San Francisco news conference, law enforcement authorities said the charges marked their first, but hardly their final, attempt to crack down on illegal option practices that flourished during the economic boom of the late 1990s.

SEC Chairman Christopher Cox said the agency is moving to "stamp out" abusive stock-option moves. Enforcement chief Linda Chatman Thomsen told reporters that her unit alone had launched 80 investigations.

At Brocade, authorities maintain, executives improperly backdated the awards for new and current employees from 2000 to 2004 to give the workers an immediate paper gain. The moves did not affect the company's stock price, as defense lawyers argued yesterday. But they did, regulators say, present a misleading financial picture to investors because the backdating triggered rules in effect at the time that would have required Brocade to treat the options as a compensation expense.

Regulators say those moves helped Brocade understate its expenses and overstate its income by millions of dollars over several years.

Reyes, 43, had substantial authority to make stock-option grants according to power vested in him by board members. Prosecutors yesterday called him a "committee of one." He left the chief executive post at Brocade under pressure in January 2005, shortly after the company made the first of two restatements to its earnings because of accounting problems related to stock options. He remained on the board of directors until July 2005.

Reyes, a part owner of the San Jose Sharks, a professional hockey team, has deep roots in Silicon Valley. His father, Gregorio, sits on the board of multiple technology companies, and his uncle George is the finance chief at Google Inc.

Richard Marmaro, a defense lawyer for Reyes, said his client did not gain financially from the options maneuvers, pointing out that Reyes did not award himself any stock options. Marmaro, of Skadden Arps LLP in Los Angeles, added that his client had no "intent to misstate the financial statements of the company."

Jensen, 48, joined Brocade in 1999 and eventually retired as a consultant to the company in August 2004. Jan Nielsen Little, a lawyer for Jensen at Keker & Van Nest LLP in San Francisco, said her client "had no responsibility for finance or accounting" and vowed to fight the charges in court.

A lawyer for Canova, 44, did not return calls.

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