Brocade backdating stock options
As a result, numerous companies are conducting internal investigations to determine if, when, and how backdating occurred, and are filing amended earnings statements and tax forms to show the issuance of “in the money” options in place of the “at the money” options that were previously reported.This is not always the case, according to a ruling by federal judge William Alsup of the U. District Court for the Northern District of California.“Everybody is watching it with respect to how a jury will respond to these kinds of allegations,” said attorney Charles Ross, former head of the white collar defense group at Herrick, Feinstein LLP.“It’s a pretty strong case for the defense, but if there’s a conviction, the Justice Department will be emboldened to bring these coin-toss cases” where the outcome is uncertain, he said. Experts said it may be difficult to convict Reyes because both sides agree he did not profit personally from the backdating, in which option grants were retroactively priced on days when Brocade’s stock was low, maximizing gains for employees.Numerous financial analysts replicated and expanded upon the prior academic research, developing lists of companies whose stock price performance immediately after options grants to senior management (the purported dates of which can be ascertained by inspecting a company's Form 4 filings, generally available online at the SEC's website) was suspicious.For instance, public companies generally grant stock options in accordance with a formal stock option plan approved by shareholders at an annual meeting.According to a study by Erik Lie, a finance professor at the University of Iowa, more than 2,000 companies used options backdating in some form to reward their senior executives between 19.The SEC’s opinions regarding backdating and fraud were primarily due to the various tax rules that apply when issuing “in the money” stock options versus the much different – and more financially beneficial – tax rules that apply when issuing “at the money” or "out of the money" stock options.
In essence, the revision enabled companies to increase executive compensation without informing their shareholders if the compensation was in the form of stock options contracts that would only become valuable if the underlying stock price were to increase at a later time.
San Jose, California-based Brocade is the world’s largest maker of data-storage network switches. While prosecutors are not required to prove that Reyes profited personally, jurors may be more lenient if he did not do so.
The lack of a personal financial motive distinguishes the case from more-notorious securities-fraud cases such as Enron Corp ECSPQ. “If I were a prosecutor, I’d be reluctant to bring a case against a guy who didn’t make any money on the deal,” said Joseph Bartlett, an attorney at Fish & Richardson in New York and a former acting professor at Stanford Law School.
When company executives discovered that they had the ability to backdate stock option grants, thus making them both tax deductible and “in the money” on the date of actual issuance, the common practice of stock option backdating for financial gain began on a widespread level.
The problem with this practice, according to the SEC, was that stock option backdating, while difficult to prove, could be considered a criminal act.