Judge: Brocade CEO’s crimes caused no loss

December 8, 2007, 7:35 AM UTC

Though it must be hard for him to celebrate, Brocade’s (BRCD) former CEO Gregory Reyes — convicted of 10 felonies last August in connection with options backdating at the company — actually got some good news this week.

On Wednesday, shortly after a federal jury convicted his former human resources chief Stephanie Jensen on two felony counts stemming from the same scheme, U.S. District Judge Charles R.  Breyer of San Francisco unsealed an order he had already entered on November 27 that will have a major, positive bearing on Reyes’ sentence.

Breyer found that the government had failed to “quantify any amount of loss that can be attributed to Reyes’ conduct.” As a consequence, he calculated Reyes’ recommended sentencing guidelines range to be 15-21 months, almost 20 times lower than the top range proposed by the government: 292-365 months. The ruling is here      

The government had proposed four alternative methods for estimating the size of the pecuniary loss caused by Reyes’ crimes, but Breyer rejected all of them.  

First was a “market cap” approach, in which it toted up the total of number of shares sold on January 7, 2005 — the day after Brocade disclosed that it would need to make a restatement, due to options backdating — times the $0.52 stock drop that occurred that day, as Brocade shares fell from $6.92 to $6.40 in value. That arithmetic produced a $3.2 million figure.

Breyer said that number was inflated as an estimate of loss, though, because so many shares sold that day had probably been purchased at prices much lower than $6.92. (For the two years preceding January 7, 2005, Brocade’s average closing price had been $5.92.)  

Next, the government suggested simply using as a measure of loss the amount of the civil fine Brocade paid to the Securities and Exchange Commission — $7 million — or the amount it voluntarily paid to the Internal Revenue Service to cover the tax obligations of the employees who had received the backdated options. But no judge had ever before used those benchmarks for criminal sentencing purposes, and Breyer declined to become the first. 

Third, the government suggested an estimate called “rescissory loss.” It computed the average trading price of Brocade shares during the entire four-year span of the scheme — going back to January 26, 2001, when Brocade’s price stood at a stratospheric $108.38 — and then compared that number to Brocade’s average trading price during the five weeks immediately following the announcement of the need for a restatement. Assuming that the reduction in value of nearly every share between those two periods could then be attributed to the backdating scheme, the government calculated a loss of between $2.5 billion and $3 billion. But Judge Breyer found that loss to be “overwhelmingly the result of extraneous factors” — mainly the popping of the tech bubble.  

Finally, the government suggested that the court calculate Reyes’s “personal gains” from the scheme, but Judge Breyer found that there weren’t any — at least none that could be proven by clear and convincing evidence.

Though Breyer has now calculated Reyes’s recommended guideline range, he still has some discretion to vary upward or downward from it. He has not yet scheduled a date for Reyes’s sentencing.  

Richard Marmaro, Reyes’s lead counsel, declined comment on Judge Breyer’s order.