SAN FRANCISCO -- Federal regulators are making it clear that they are taking the stock-options backdating issue very seriously. On Thursday, they filed criminal and civil charges against several former executives at Brocade ( BRCD), including former CEO Gregory Reyes. The cases allege that the executives defrauded investors by falsifying documents and knowingly releasing misleading income statements. While the charges were the first of their kind in the broader backdating scandal, government officials said they wouldn't be the last. The Securities and Exchange Commission, for instance, is now investigating backdating allegations at more than 80 companies, said Chairman Christopher Cox at a press conference here. The commission expects to file additional enforcement actions in the "coming weeks and months," he said. Backdating "goes to the heart of the relationship between a corporation and its shareholders," Cox said, adding that the practice "deceives investors and the market as a whole." "We're using the full weight of the federal government to stamp out fraudulent stock options backdating," he added. Stock options give employees and executives the right to buy their company's stock at a pre-set price. Under most company stock plans, that exercise price is supposed to be the market price of the stock on the date the options are granted. But companies caught up in the backdating scandal are accused of granting options that carried exercise prices from dates days or weeks prior to the actual grant date. In many cases, these exercise prices corresponded to short-term lows in the companies' stocks. Essentially, companies are alleged to have given employees and executives options that were already in the money by the time they were handed out. The legality of backdating itself is questionable. The key issues for federal regulators are whether companies properly disclosed that the options were backdated and whether they properly accounted for those options. Under accounting rules that were recently phased out, companies only had to recognize an expense for employee stock options if they had a nominal value when they were handed out; in other words, if they were in the money.
In Brocade's case, company officials are alleged to have deceived investors about the actual grant dates and, in the process, to have falsely accounted for the options. Federal officials charge that Stephanie Jensen, the company's former vice president of human relations, under direction from Reyes, falsified documents related to options granted between 2000 and 2004. The intention was to make it appear as if the options carried an exercise price from the same day that it was granted, federal officials said. In reality, the exercise price came from days or weeks before the actual grant date. In fact, in some cases, the falsified dates made it look as if some employees received options grants before they were even hired by the company, according to federal officials. Federal prosecutors have charged both Reyes and Jensen with one count of criminal financial fraud. In the civil complaint, the SEC has alleged eight counts of fraud against Reyes, Jensen and former CFO Antonio Canova. The SEC alleges that Canova became aware of the alleged backdating after he joined the company in December 2000 and helped cover up the scheme. In a statement, Brocade said it has taken steps to strengthen its internal controls over financial reporting and that none of the executives involved in the alleged fraud remain with the company. Reyes resigned his CEO position in January 2005. However, he stayed on with the company as a board member until April 2005 and as a consultant until July last year. Canova resigned from the company last December and Jensen retired from Brocade in August 2004. Brocade has since
restated its earnings from 1999 through 2004 to reflect the in-the-money options grants. The company has proposed paying $7 million itself to settle any charges against it by the SEC.
But Brocade is only the furthest along among the companies being investigated by the SEC. Among other companies under scrutiny are
UnitedHealth ( UNH) and Intuit ( INTU). Other companies, such as Apple Computer ( AAPL) and Activision ( ATVI) are also the subject of either internal or external investigations into their options practices, but have not yet acknowledged being the subject of regulatory inquiries. The backdating investigation has been weighing heavily on the technology sector . Not only have tech companies been the most prolific dispensers of stock options, but they've also represented the lion's share of companies alleged to have backdated shares.