Stock Option Backdating: A Win For the Government In Reyes Suggests a Narrower Focus in Future Cases

Today, a jury found former Brocade Communications Systems, Inc. CEO Gregory Reyes guilty on all charges in a case based on backdating stock options.  This is the first government enforcement action – civil or criminal – to go to trial.  That the government prevailed should not be surprising.  The Brocade case is the first options backdating case and was announced with great fanfare by the U.S. Attorney’s Office for the Northern District of California and the Securities and Exchange Commission in a joint press conference.  The allegations in the parallel criminal and civil enforcement actions suggested very strong cases.  Indeed, the government should be expected to select their best case to begin. 

What is perhaps surprising is the drawn out decision by Judge Breyer on the defense Rule 29 motion for acquittal, which was keyed to whether Mr. Reyes understood or knew much about the critical accounting issues involved.  Equally surprising is the length of time which the jury took to come to a verdict.  While this was clearly a big win for the government, at the same time it should be pause for reflection.  Judge Breyer’s long deliberations and those of the jury should at least suggest that prevailing in these cases is not a slam dunk.  

At the same time, every company and corporate official involved in the 140 or so investigations the SEC reportedly has underway (as well as those in parallel criminal investigations) must be wondering what this verdict means for them.  Had the government lost, it might have meant a re-evaluation of options backdating cases.  A win, however, should not necessarily mean “full steam ahead.”  No doubt that the verdict means that the government is on the right track with its option backdating cases.  At the same time, the fact that the verdict was hardly a slam dunk and at least appears to have been obtained only with significant difficulty in the government’s lead case, should at least suggest to government prosecutors and SEC enforcement officials that any future cases based on claims of option backdating be very carefully evaluated in terms of the knowledge of the individuals claimed to have been involved and their understanding of the accounting issues and the impact of those issues on the company.  At the end of the day, all of this suggests that government prosecutors would do well to proceed with a more narrow focus than a win in this case might otherwise indicate.