On the heels of last week’s Justice Department conviction of Brocade Communications Systems’s former CEO Gregory Reyes, the Securities and Exchange Commission has charged the company’s onetime chief financial officer with helping to backdate millions of dollars worth of stock-option grants to lure employees to the high-tech company.
In its complaint released Friday, the SEC asserts that Michael J. Byrd, who retired from Brocade as chief operating officer in 2003, repeatedly disregarded evidence that other senior executives — including Reyes — were improperly backdating stock-option awards as far back as 2000. The commission also alleges that Byrd falsified documents to hide the backdating improprieties, and failed to account for the options correctly in an attempt to avoid the related balance-sheet expenses.
The SEC complaint cites instances in which Brocade purported to grant options to new employees on dates before they had even been hired. The SEC also claims that Byrd, a former Ernst & Young partner, was personally involved in interviewing some of these executives and therefore had knowledge that the option paperwork was being falsified so that employees could receive lucrative “in-the-money” options.
“Mr. Byrd was in a position to identify accounting irregularities and provide Brocade’s shareholders with honest, accurate information,” says Marc Fagel, associate regional director of the SEC’s San Francisco office. “Instead, we believe he turned a blind eye to the misconduct by senior executives and signed off on fraudulent financial statements.”
But Byrd’s attorney, John M. Potter of San Francisco firm Quinn Emanuel Urquhart Oliver & Hedges LLP, argues that the SEC’s civil case is completely at odds with the one advanced by federal prosecutors to convict Reyes.
In a prepared statement sent to CFO.com, Potter argues that Reyes “pinned his defense on the claim that his stock option backdating practices were known to Mr. Byrd and other members of Brocade’s Finance Department, who failed to expense the options.” But federal prosecutors rejected that defense, says Potter, quoting a court transcript of the federal prosecutor saying “finance was deceived.”
Indeed, says Potter, in a July response to a motion by Reyes’s attorneys to dismiss the case, prosecutors argued that “Brocade’s Finance Department was not told about the regular practice of using look-backs to award stock option grantsÂ .”
“The issue of Mr. Byrd’s knowledge of the stock option backdating practices at Brocade has already been litigated,” says Potter, noting the jury convicted Reyes despite his claims that Byrd knew of the backdating. “We fully expect that, if this case is eventually tried, another jury will reach the same conclusion.”
Byrd was originally expected to testify against his former boss during the trial, but was never called as a witness for the prosecution. In a follow-up interview with CFO.com, Potter said he did not know why Byrd was never called, but said his client had cooperated fully with both the SEC and the DoJ as a witness, and that at no point in the investigation had his client assumed status as a target of federal prosecutors. “He never entered into a cooperation agreement,” Potter told CFO.com. “He volunteered his cooperation as a witness.”
The SEC’s complaint, filed Friday in federal district court in San Francisco, also alleges that Byrd received a backdated option grant after being named chief operating officer in 2001. Further, it asserts Byrd filed a disclosure statement with the commission falsely claiming the option had been granted on an earlier date. According to the SEC, Byrd received 800,000 in-the-money options, which at the time of the grant gave him an immediate paper gain of about $16 million.
The SEC is seeking disgorgement of alleged ill-gotten gains and civil penalties from Byrd. It is not seeking to have Byrd barred from acting as an officer or director of a public company, though the commission did seek such bars against both Reyes and Antonio Canova, who became CFO after Byrd was promoted to COO.
While the SEC can only bring civil charges, the government’s win against Reyes, which was the first backdating case to reach trial, is expected to open the floodgates for criminal charges against other executives at companies where stock-option backdating has been identified. Indeed, government attention to the national scandal over backdating has led it to target more than 140 companies for investigation, although so far only 10 executives have been charged.