SAN FRANCISCO (AFX) - Lawyers for the first two executives charged with backdating stock options in a widening federal crackdown say their clients did not willfully violate securities laws, offering a first look at how companies accused of the practice may defend themselves.
Gregory Reyes, the former chief executive of Brocade Communications Systems Inc. and Stephanie Jensen, Brocade's former vice president of human resources, go to court Wednesday. The ex-officials at the San Jose-based maker of data storage devices were charged with securities fraud here last month, and their lawyers are demanding the cases be dismissed.
'Even if every fact alleged by the government in the affidavit submitted with its complaint were true, those facts would still be insufficient to allege the requisite criminal intent,' Jensen's attorney, Jan Nielsen Little argued in court papers. Last month, she decried the charges as 'wrong-headed.'
If convicted, each faces a maximum penalty of 20 years in prison and a $5 million fine.
Reyes' attorney, Richard Marmaro, said there is no evidence of self-enrichment. In an interview, he said 'there was no intent to commit securities fraud. He had no intent to falsify the financial statements of the company.'
In court papers, he wrote that defendants accused of breaching securities rules cannot be imprisoned 'if he proves that he had no knowledge of the rule.'
Prosecutor Christopher Steskal argued in court papers that 'this is not the law.'
'The government,' he said, 'does not have to prove that the defendants knew they were breaking the law to establish securities fraud.'
Carl Tobias, a professor at the University of Richmond School of Law, said that defense has better odds before a jury than a judge.
'We have always said ignorance of the law is not an excuse,' Tobias said.
Elizabeth Nowicki, a former Securities and Exchange Commission attorney who teaches securities regulation at Cornell Law School, suggested the pair might have a good defense.
'The courts are likely to conclude they didn't have intent to deceive, manipulate or defraud because everybody was doing this and everybody thought it was legal,' she said. 'Because everybody was doing it, judges might find it was reasonable for everybody to think it was fine.'
Dozens of U.S. companies have disclosed their stock options practices are being investigated by the Department of Justice or the SEC. At issue in many of the probes -- and a central allegation in the Reyes-Jensen case -- is a practice known as backdating, in which options are retroactively issued to coincide with low points in a company's share price.
Reyes resigned in January 2005, shortly after Brocade announced an internal audit had uncovered suspicious accounting of stock options, which allow employees to buy shares of their company's stock in the future at a set price -- and potentially reap a big windfall if share prices later rise.
Companies began increasingly relying on options in the late 1990s, when executives touted them as an important compensation and retention tool and as a way to align employees' and shareholders' interests.
Stock options give a person the right to buy shares in the future at a set fee, often called an exercise price. If the stock price rises following the granting of the options, they can represent a profit worth millions of dollars.
According to the government, Reyes and Jensen authorized options grants with exercise prices that were below the price of Brocade's stock on the day they were issued, giving the recipients an immediate paper profit.
Reyes, who in 2000 landed on Forbes list of the 400 richest Americans, then backdated the documents so prices appeared to be the same as the company's share price on the date they were issued, according to the government.
Authorities also allege Reyes and Jensen regularly backdated board of director meeting minutes so that it appeared the stock options committee granted options on dates that Brocade's share price was relatively low. Authorities allege no such meetings occurred on those dates.
The pair also had employment offer letters backdated so workers would receive options that were dated at low points in the company's share price that predated their first day of work, according to the criminal complaint.
Brocade, which was once worth as much as $24 billion, had to restate financial results for fiscal years 1999 through 2004, shaving 20 cents off previously reported earnings per share figures. The company today is valued at about $1.6 billion.
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