DOJ, SEC Charge Brocade Execs

CFO and others are charged in the first options backdating suits to be brought by government prosecutors and regulators.

Federal prosecutors and regulators filed criminal and civil fraud charges against three Brocade Communications Systems executives on Thursday for participating in an alleged stock options backdating scheme that concealed “millions of dollars in expenses from investors” and significantly overstated the company’s income.

The Department of Justice lodged criminal charges against Gregory Reyes, the former CEO, president, and chairman of Brocade and Stephanie Jensen, the company’s former vice president of human resources, for regularly backdating stock-option grants “to give employees favorably priced options without recording necessary compensation expenses.”

At the same time, the Securities and Exchange Commission launched a civil suit against Reyes, Jensen, and Antonio Canova, Brocade’s former CFO. Canova is charged with not taking action after learning of the alleged backdating scheme and later certifying false and misleading financial statements. According to the civil complaint, Canova was aware that options grants were being backdated and not disclosed, yet failed to alert Brocade’s audit committee and auditors.

The lawsuits against the three former executives followed an 18-month investigation by the SEC and FBI. The suits are the first to emerge from government investigations into corporate options timing practices. Reportedly, more than 60 companies are either under investigation by the SEC or DOJ for backdating option grants or are being sued by shareholders based on suspect options practices.

Backdating options grants to a time when the underlying company stock traded at a lower price usually provides the options holder with an immediate paper gain and a real gain when the options are exercised. The practice is illegal if it is not disclosed in financial filings.

The DOJ suit, filed in federal court in San Francisco, charged Reyes and Jensen with securities fraud. The SEC’s civil complaint, filed in federal court, charged Reyes, Canova, and Jensen with fraud and other violations of securities law, including falsifying books and records, misrepresenting financial filings to auditors, and violating Sarbanes-Oxley certification provisions.

The maximum penalties for criminal securities fraud is 20 years in prison and a fine of $5 million, according to a DOJ statement. The SEC is seeking disgorgement of the trio’s alleged “ill-gotten gains” as well as payment of penalties. SEC attorneys are also seeking to bar Reyes and Canova from serving as officers or directors of public companies.

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