Former Brocade Communications CEO Gregory Reyes, the first executive to go on trial for backdating stock options, was convicted Aug. 7 on 10 felony counts, including securities fraud, conspiracy, and filing false financial statements. He faces up to 20 years in prison and a $5 million fine when he’s sentenced in November.

The most significant part of this verdict may be that jurors were persuaded by prosecutors' arguments that backdating is a crime and not just an immaterial accounting mistake.

“The jury’s verdict recognized that backdating option grants with an intent to deceive as done in this case is a crime,” U.S. Attorney Scott Schools, whose oversaw the prosecution, said in a press release. "Shareholders, large and small, rely on the accuracy of the information provided to them by public companies like Brocade."

Last month, Securities and Exchange Commission Chairman Christopher Cox publicly pledged to accelerate the agency’s resolution of option backdating investigations, and recent weeks have seen a surge in enforcement activity by the SEC and federal prosecutors.

Since mid-July, prosecutors have announced criminal charges against former executives at SafeNet, Brooks Automation, and DRS Technologies’ Engineered Support Systems unit. Meanwhile, the SEC has unveiled civil settlements with KLA-Tencor and Integrated Silicon Solution and opened formal probes of Verint Systems, Verisign, Pediatrix Medical, and CNET Networks. Prosecutors have also filed criminal charges against Brocade’s former vice president of HR, Stephanie Jensen -- her trial date has not been set.

San Jose, California-based Brocade, which makes switches for data storage networks, reached a $7 million civil settlement with the SEC in late May. That settlement--and a $28 million accord with Hewlett-Packard's Mercury Interactive unit--were delayed for months amid disagreement among the SEC commissioners over the size of penalties the agency should seek from companies, according to news reports. Observers say the internal debate centered on how serious a problem options backdating should be considered.

More than 220 companies have disclosed internal and/or federal investigations into their option grants since March 2006. At least 100 have announced that they must restate financial results. So far, those restatements, financial revisions, and charges total $12.7 billion, according to Bloomberg News. Brocade restated its financial results twice in 2005, adding about $101 million in expenses to account for option irregularities.

Backdating on Trial
Prosecutors alleged that Reyes repeatedly used hindsight to select favorable grant dates between 2000 and 2004, so the options would be “in the money” when granted. Reyes and other company officials then falsified compensation committee minutes and other documents to make it appear that the options in fact were "at the money" on those dates, prosecutors said. At that time, U.S. companies didn’t have to record "at the money" options as an expense, so Brocade was able to reduce its compensation expenses and increase its earnings.

The verdict in Reyes’ eight-week trial surprised his lawyers and some legal observers because he didn’t benefit personally from the backdated grants and there was no direct evidence that he ordered the manipulation of option dates. But prosecutors pointed to SEC filings signed by Reyes that asserted that stock options were properly accounted for. Jurors apparently also were swayed by testimony that Reyes misled an outside lawyer who was retained to investigate the company’s option grants in 2004, according to The Recorder, a San Francisco legal newspaper.

Reyes’ lawyer, Richard Marmaro, argued that backdating isn't illegal and that the government failed to prove that Reyes knew about the detailed accounting rules that govern stock options. Marmaro also claimed that investors don’t pay attention to non-cash expenses like options when making investment decisions.

After the verdict, Marmaro said he would file an appeal and proclaimed his client’s innocence. "We are confident he will ultimately be exonerated. At all times, he acted in the best interests of the employees and shareholders of Brocade," the defense lawyer said in a statement.