Greg Reyes, the former CEO of Brocade Communications Systems, became the first U.S. chief executive tried and convicted in the stock options backdating scandal of the mid-2000s. After a first conviction was thrown out for prosecutorial misconduct, he was retried in 2010, convicted on nine of ten counts, sentenced to 18 months in federal prison and fined $15 million, and separately settled a civil fraud case with the Securities and Exchange Commission. He later received a presidential pardon from Donald Trump.
What the Scheme Actually Did
Reyes ran Brocade, a San Jose networking company, from 1998 to 2005, taking it public in 1999 during the dot-com boom. From roughly 2000 through 2004, according to prosecutors and the SEC, he selected stock option grant dates by looking backward and picking days when Brocade’s share price had been at a low. That made the options “in the money” the moment they were issued, while the paperwork showed them granted at fair market value.1FBI San Francisco. Former CEO of Brocade Communications Systems Convicted
Because Brocade recorded these grants as if they carried no extra compensation cost, the company avoided reporting hundreds of millions of dollars in expenses and made its earnings look better than they were. SEC testimony put the inflation of Brocade’s net income at as much as $1 billion in the year 2000 alone.2SEC. Testimony Concerning Options Backdating Compensation committee minutes and employee offer letters were falsified to conceal the true grant dates. Reyes himself received more than 13 million backdated options over four years, netting him roughly $2 million.1FBI San Francisco. Former CEO of Brocade Communications Systems Convicted
Two other Brocade officers were central to the case. Stephanie Jensen, the former VP of human resources, built the documentation system that made the backdating possible. Antonio Canova, the former CFO, learned of the practice, failed to report it, and helped reconcile conflicting records to deceive auditors.3SEC. SEC Charges Three Former Officers of Brocade Communications
How Investigators Found It
The Brocade investigation grew out of academic work by Erik Lie, a University of Iowa finance professor. In a 2005 study, Lie documented that stock prices consistently dropped just before executive option grants and rose just after, a pattern he concluded could only be explained by grant dates being chosen retroactively.4INFORMS. On the Timing of CEO Stock Option Awards He estimated that about 29 percent of firms granting options to top executives between 1996 and 2005 had manipulated at least one grant.5University of Iowa. Backdating of Executive Stock Options
The SEC’s Office of Economic Analysis used Lie’s methodology to develop investigative leads, and at its peak the agency was examining at least 140 companies, with roughly 70 executives losing their jobs across the industry.6CPA Journal. Brocade Communications Stock-Option Backdating Brocade was the case federal prosecutors chose to test their theory in criminal court.
The Criminal Case: Two Trials
Reyes was indicted on August 10, 2006, in the Northern District of California on charges including securities fraud, making false SEC filings, falsifying corporate books and records, and making false statements to auditors.7FBI San Francisco. Former CEO of Brocade Sentenced
First Conviction and Reversal
A jury convicted Reyes on all 10 counts in August 2007. He was sentenced to 21 months in prison and a $15 million fine, becoming the first corporate CEO in the country to be convicted at trial in a backdating case.8SF Examiner. Former Brocade CEO Gets Prison, $15M Fine for Backdating Stock Options
On August 18, 2009, a three-judge panel of the Ninth Circuit vacated the conviction. The panel found that prosecutors had told jurors during closing arguments that Brocade’s entire finance department was unaware of the backdating, when the FBI’s own interview notes and parallel SEC civil filings showed that senior finance executives, including controller Bob Bossi and CFO Antonio Canova, had in fact known.9Stanford Law School. 9th Circuit Tosses Reyes Backdating Conviction Due to Prosecutorial Misconduct10U.S. Court of Appeals for the Ninth Circuit. United States v. Reyes, No. 08-10047 The court ordered a new trial.
Retrial and Second Conviction
The retrial ran before U.S. District Judge Charles R. Breyer in early 2010. After a four-week trial and three and a half days of deliberation, the jury on March 26, 2010, found Reyes guilty on nine of ten counts: four counts of securities fraud, four counts of lying to accountants, and one count of false books and records. He was acquitted on the conspiracy charge. The defense called no witnesses, arguing that the government had not proved its case.11Mercury News. Brocade Ex-CEO Gregory Reyes Guilty on 9 of 10 Counts in 2nd Backdating Trial
Sentence and Appeal
On June 24, 2010, Judge Breyer sentenced Reyes to 18 months in federal prison, a $15 million fine, and a $900 special assessment. Prosecutors had asked for 37 months and a $33 million fine.7FBI San Francisco. Former CEO of Brocade Sentenced Reyes was ordered to surrender to the U.S. Marshal on September 10, 2010.
He appealed. On October 13, 2011, the Ninth Circuit affirmed the second conviction, rejecting his prosecutorial misconduct arguments, finding sufficient evidence of materiality given the nearly $1 billion overstatement of Brocade’s net income, and finding no error in the jury instructions.12FindLaw. United States v. Reyes, No. 10-10323
The SEC Civil Settlement
The SEC filed a parallel civil fraud action against Reyes, Jensen, and Canova on July 20, 2006, alleging violations of antifraud, books-and-records, internal controls, and Sarbanes-Oxley certification provisions.3SEC. SEC Charges Three Former Officers of Brocade Communications Reyes settled on August 18, 2011, without admitting or denying the allegations. The final judgment required him to pay $150,000 in disgorgement, $145,219.74 in prejudgment interest, and a $550,000 civil penalty, and barred him from serving as an officer or director of any public company for ten years.13SEC. Final Judgment Against Gregory L. Reyes
What It Cost Brocade
The scandal forced Brocade to restate six fiscal years of results, 1999 through 2004, with total restatement charges of $351 million.6CPA Journal. Brocade Communications Stock-Option Backdating The company’s 2004 loss widened from $2 million to $32 million, and Brocade added $71 million in additional expenses from improper option accounting.14Accounting Today. Brocade to Pay $160M in Backdating Settlement The stock, which had peaked near $134 in October 2000, fell to about $3.34 by November 2005. A shareholder securities class action was settled for $160 million.
The Pardon and What Reyes Does Now
After completing his prison sentence, Reyes became involved with Prison Professors, a nonprofit founded by Michael Santos that works with people navigating the federal prison system. According to the organization, Reyes began sponsoring the nonprofit while incarcerated alongside Santos and continues to serve as a sponsor advisor. He subsequently received a presidential pardon from Donald Trump.15Prison Professors. Our Team