RED FLAGS IN THE BACKDATING CASES: DO THE PROSECUTIONS HAVE MERIT?
Prosecutors frequently point to “red flags” as proof of knowledge. Typically, the red flags are a series of facts or events which demonstrate that either person knew or was reckless in not knowing. A series of these red flags have emerged in the stock option backdating cases. Faced with these red flags, Attorney General Eric Holder and SEC Chairman Mary Schapiro should immediately review the merits and propriety of these prosecutions.
Red flag number one is the acquittal on criminal stock option backdating charges of former McAfee, Inc. General Counsel Kent Roberts, discussed here. DOJ brought multiple fraud charges against Mr. Roberts, claiming he engaged in criminal conduct when the company backdated its stock options. The SEC chimed in with parallel civil fraud charges. The jury and the court found otherwise. Following a trial on the merits, Mr. Roberts was acquitted on the key charges. Jurors deadlocked some which the trial judge strongly recommended be dropped. DOJ followed the judge’s prescription. So did the SEC.
While there is no doubt that options were backdated at McAfee, that does not mean there was intentional fraud requiring criminal or even civil law enforcement fraud actions. Indeed, the fact that DOJ lost this case should, at a minimum, raise questions, since the government typically prevails in criminal cases. Those concerns should be intensified by the fact that the jury deadlocked on a few charges requiring the judge intervene to avoid a possible miscarriage of justice since the facts clearly were not there to support the charges. Fortunately the ordeal has ended for Mr. Roberts. For others, however, it continues.
Red flag number two is the case of former Brocade CEO Gregory Reyes. There, the U.S. Attorney’s Office and the SEC unveiled their cases with great fanfare, holding a joint press conference in San Francisco. The prosecutors claimed to have evidence of clear, intentional fraud on the shareholders to support their charges. Mr. Reyes was tried and convicted. The truth-finding processes of the trial, however, were flawed by intentional overreaching and misconduct by the government, concluded the court of appeals. The government intentionally misled the jury by misstating and misrepresenting key evidence, as discussed here.
When prosecutors distort the evidence to win, it raises a serious red flag, not just about the misconduct, but also the quality of the evidence. If the evidence is solid, there is no need for such conduct. The fact that prosecutors felt compelled to skew the fact-finding process with overreaching is a virtual admission that the prosecution is deeply flawed and that the claims announced with such drama at the press conference are not firmly grounded in the facts.
The recent rulings in the Broadcom cases raise more red flags. There, the government brought criminal and the SEC brought civil fraud charges against company co-founders Henry Samueli and Henry Nichols and former CFO William Ruehle. The three men faced multiple fraud charges from DOJ and the SEC based on the backdating of stock options at Broadcom. The charges hinged on the question of whether the three intended to defraud the shareholders, not if the options had in fact been backdated, which they were.
As these cases moved forward, the government offered Mr. Samueli a deal he could not afford to pass. All charges and the prospect of serving years in prison would be dropped if he pleaded guilty to one count of making a false statement during his SEC investigative testimony. Of course, the deal bolstered the government’s case against the others by seemingly precluding Mr. Samueli from denying culpability for the backdating of the options at Brocade as he had during his SEC testimony.
The deal the government crafted was wrong. During the Mr. Ruehle’s trial, Mr. Sameuli testified for two days under a court ordered grant of immunity – the government refused the immunity request, apparently to keep him off the witness stand. After listening to the testimony, Judge Carney concluded that Mr. Samueli had not made a false statement and that there was no factual basis for the guilty plea. The government had improperly made the deal and accepted the plea. The court ordered the plea vacated as discussed here.
The message of the sham Samueli plea should do more than raise a red flag. It presents a question about the propriety of these cases. The fact that DOJ prosecutors crafted a plea deal with no factual predicate in violation of the Mr. Samueli’s rights and their obligations is nothing but overreaching coupled with an improper zeal to win, rather than see justice done. At the same time, the fact that Mr. Samueli, man who clearly has the means to fight the wrongful prosecution was bludgeoned into this baseless deal speaks volumes. It fully illustrates the power and pressure of a federal prosecution and the high prospects for incorrect results when prosecutors fail to honor their obligations and over reach. This is particularly true for many individuals who, unlike Mr. Samueli, do not have the resources to effectively litigate with the government.
The dismissal of all charges against Messrs. Ruehle and Nichols is final red flag which should spark Mr. Holder and Ms. Schapiro to action. Again the basis was prosecutorial misconduct. In making its ruling, the court found that the government had threatened and intimidated witnesses noting: “To submit this case to the jury would make a mockery of Mr. Ruehle’s constitutional right to compulsory process and a fair trial. The Sixth Amendment . . . guarantees the accused the right to compulsory process for witnesses in its defense. For this constitutional right to have true meaning, the Government must not do anything to intimidate or improperly influence witnesses. Sadly, [the] Government did so in this case.” Since this type of misconduct goes to the heat of the truth-finding processes on which the criminal justice system is based, there was no choice but to dismiss the charges.
In its ruling, the court also concluded that the government has insufficient evidence to sustain a conviction as to Mr. Ruehle. Finally, the court dismissed without prejudice the SEC’s parallel civil fraud case, strongly recommending that it not be refilled.
Viewed individually or collectively, these red flags raise troubling questions. When DOJ not only loses a case, as with Mr. Roberts, but does not have the evidence as the judge stated and in other cases misleads the jury, crafts a sham plea agreement and intimidates witnesses, the propriety of these prosecutions is called into question. This point is bolstered by the fact that these red flags stem from prosecutions involving transactions at three different companies and in two different jurisdictions clearly belying any claim that these are isolated instances.
Faced with these red flags, it is incumbent on Mr. Holder and Ms. Schapiro to conduct a careful review and scrutinize the evidence in each case. As Mr. Holder stated when he announced the dismissal of charges in the prosecution of Senator Stevens, the government as sovereign and prosecutor has unique obligations not to win but to ensure that justice is done.
There is no doubt that the government has an obligation to prosecute when appropriate. At the same time, it also required not just to avoid violating the rights of the accused, but to safeguard them. Our system of justice only functions properly when the government honors and fully implements both of those obligations. Before any more stock option backdating cases are litigated, it is incumbent on the Justice Department and the SEC to revisit their cases, reassess the merits of each and ensure that prosecutors are fully meeting their duel obligations. Justice depends on it.