WASHINGTON/SAN FRANCISCO: U.S. authorities on Thursday (July 21, 2006) charged former officers of technology group Brocade Communications Systems Inc. with fraud in the first court actions to result from an investigation of corporate stock option grants that has spread to 80 companies.

Federal prosecutors and the FBI filed criminal securities fraud charges against Brocade's former chief executive, Gregory Reyes, and its former human resources vice president, Stephanie Jensen.

The Securities and Exchange Commission filed related civil charges against both Reyes, 43, and Jensen, as well as Brocade's former chief financial officer, Antonio Canova.

From 2000 to 2004, authorities alleged, Brocade hid millions of dollars in expenses from investors and overstated its income by falsifying employee stock option grant records.

"By falsifying and backdating option paperwork, Reyes and Jensen knew investors would be given a false portrait of Brocade's financial condition," said SEC Enforcement Director Linda Thomsen at a news conference in San Francisco.

"Canova contributed to this false portrait by continuing to certify Brocade's false filings even after learning option paperwork had been forged," Thomsen said.

The SEC said it is investigating 80 companies. "This case will not be the last," Thomsen said.

Authorities are trying to determine if companies manipulated the grant dates of stock options to boost the profits available to corporate executives who got them.

Richard Marmaro, defense attorney for Reyes, said that his client was innocent. "If the government wants to make an example of an executive abusing stock option grants, it is choosing the wrong person," Marmaro said.

Attorneys for Jensen, 48, and Canova, 44, could not immediately be reached for comment.

No charges were brought against Brocade, a San Jose-based company that makes hardware for computer networking storage. Its shares closed down 11 cents at $5.91 each in broadly lower Nasdaq trading.

The company said that no executives involved in its past option granting practices remain employed at the company. It said it restated past results twice in 2005 after an internal inquiry.

In the 2006 first quarter, the company said, it reserved $7 million for a proposed SEC settlement. "Brocade continues to cooperate," it said.

Straight to the CEO

Jacob Frenkel, attorney at the law firm of Shulman Rogers Gandal Pordy & Ecker in Rockville, Maryland, said the fact that the Brocade case went straight to the CEO rather than starting with junior officers suggests authorities are moving quickly.

"We're not going to see the ladder-climbing that we've seen" in other cases, Frenkel said. "We're likely to see a lot of cases in a short period of time and a rapid clean-up." The multi-agency investigation of corporate stock option practices is the latest scandal to hit corporate America and centers on two main patterns of potential misconduct.

A stock option is a contract giving the holder the right to buy shares of stock at a fixed strike price in the future.

The strike price is normally set as the market price of the underlying shares on the date the option is granted. Options granted this way are said to be "at the money." In one practice known as backdating, option grant dates were retroactively set to precede a rally in the underlying shares, putting the options "in the money" and locking in risk-free profits for their recipients.

In another practice known as spring-loading, grant dates were scheduled for just before a positive announcement or just after a negative one, anticipating a stock price rally and also building in profits for the option recipients.

Both practices are not outright illegal, but can run afoul of the law if not properly disclosed, taxed and accounted for. The Internal Revenue Service is also investigating.

Authorities alleged that Reyes, assisted by Jensen, used hindsight to choose dates in the past when the company's stock price was low to fix as the grant dates for options given to employees. "Brocade was able to give employees Ôin-the-money' stock options without having to recognize compensation expenses as required by accounting rules," authorities said.

Criminal securities fraud carries a maximum possible sentence of 20 years in prison and a fine of up to $5 million. Reyes and Jensen are scheduled to appear in court on Aug 2, 2006.

The SEC alleged that Canova learned about the backdating after joining the company. It said Canova "was specifically warned in writing that option paperwork had been forged to enable an employee to get favorably priced options." But, the SEC said, Canova "took no action and failed to advise Brocade's auditors and audit committee." He also signed false and misleading financial statements, it said. - Reuters