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The Honolulu Advertiser
Posted on: Friday, July 21, 2006

Pair charged in stock probe

By Carrie Johnson
Washington Post

Federal prosecutors yesterday filed the first criminal charges against a top executive who allegedly manipulated stock-option awards to give his employees a bigger payday and conceal corporate expenses.

The U.S. Attorney's Office in San Francisco, which a week ago formed a task force to probe corporate backdating of stock-option grants, accused Gregory Reyes, former chief executive of Brocade Communications Systems Inc.; and Stephanie Jensen, former human resources executive, of securities fraud in a criminal complaint.

A grand jury has not yet indicted Reyes or Jensen, who yesterday denied wrongdoing through their attorneys. Both are to appear before Magistrate Judge Joseph Spero on Aug. 2. Each could receive up to 20 years in prison and a $5 million fine if convicted, U.S. Attorney Kevin Ryan said.

In a related action, the Securities and Exchange Commission charged Reyes, Jensen and former finance chief Antonio Canova with civil violations of securities laws. Authorities say that Reyes presided over the scheme at the computer networking company in San Jose, Calif., Jensen directed others to falsify employment paperwork and board minutes, and Canova failed to blow the whistle after receiving written warnings about the issue.

The charges amount to a significant advance in a large and spreading scandal. More than 60 publicly traded companies, including Apple Computer Inc., Intuit Inc. and UnitedHealth Group Inc., have announced internal investigations or regulatory probes into their stock-option practices since the issue became public this year.

Stock options give workers an opportunity to purchase shares at a specific price and a set time frame. Employees profit from the difference between the stock price on the day the options are awarded and the price on the day they are sold. Options became an important recruiting tool in the 1990s, particularly for young companies seeking to attract top-notch talent in a competitive labor market.

An academic study released last week suggested that more than 29 percent of businesses may have tampered with stock grants between 1996 and 2005. Its authors, Indiana University professor Randall Heron and University of Iowa professor Erik Lie, reported that they had uncovered a "higher frequency" of problems among technology companies, small businesses and ventures with volatile stock prices.

At a San Francisco news conference, law enforcement authorities said the charges marked their first, but hardly their final, attempt to crack down on illegal option practices that flourished during the economic boom of the late 1990s.

SEC Chairman Christopher Cox said the agency is moving to "stamp out" abusive stock-option moves. Enforcement chief Linda Chatman Thomsen said that her unit had launched 80 investigations.

At Brocade, authorities maintain, executives improperly backdated the awards for new and current employees between 2000 and 2004 to give the workers an immediate paper gain. The moves did not affect the company's stock price, as defense lawyers argued yesterday. But regulators say they did present a misleading financial picture to investors because the backdating triggered rules in effect at the time that would have required Brocade to treat the options as a compensation expense.

Regulators say those moves helped Brocade understate its expenses and overstate its income by millions of dollars over several years.