Greg Reyes’ Day in Court

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I’m in the U.S. District Court in San Francisco this week observing the “criminal fraud trial of ex-Brocade CEO Greg Reyes”:http://www.sec.gov/news/press/2006/2006-121.htm. Reyes helped found the “storage area network company”:http://www.brocade.com/company_info/index.jsp in 1995, and coached it into one of the dotcom-era’s highest fliers by 2000. Now Reyes is being prosecuted for an alleged conspiracy to avoid properly accounting for backdated options on shares of Brocade stock, which he dolled out to his employees during the boom. His is the first criminal trial to come out of regulators’ two-year review of some 264 companies that backdated options between 1999 and 2004. “Reyes’ case opened yesterday”:http://www.bloomberg.com/apps/news?pid=20601109&sid=aTpguvQJwJ2Y&refer=home, and as I sat in court listening to the lawyers woo jurors and spar with the Judge, it occured to me that there are lessons in this legal drama for us all — and for founders, especially.

*10 Lessons From Greg Reyes’ Day in Court:*

*10) The law is enforced by example.* It’s just like kindergarten, where lots of kids might act out at once, but if you’re the tallest or loudest among them, you’re probably the one who’ll be singled out for punishment. You want to stand out? Great. Just make sure yours is an example that you can be proud of under a spotlight (and we don’t mean the klieg kind).

*9) Your low-profile human resources staff is just as important as your high-profile finance staff.* Your finance department staffers might have more MBAs, fatter salaries and the seats on the IPO roadshow bus, but your HR folks are the people who tend to the most vital concerns of _the rest of your employees_. Dotting the ‘t’s’ on everyday benefits like vacation days or even seemingly small equity compensation incentives matters, a lot. Care for the people who care for your people.

*8) The only constants in life are death, taxes…and that SEC & FASB rules will change, again!* Ben Franklin had it mostly right. A common argument made by executives involved in the options backdating scandals is that it was just too hard for them to keep up with the SEC and FASB rules because the laws, namely the “Sarbanes-Oxley Act of 2002”:http://fl1.findlaw.com/news.findlaw.com/hdocs/docs/gwbush/sarbanesoxley072302.pdf, kept changing. But hey, part of your job as a founder (whether your company is public or not) is to be prepared for change, _all kinds of change,_ so that when it comes, you can adjust accordingly for the benefit fo your business. But you can help yourself if you…

*7) Hire a compensation consultant.* Equity pay packages are great for cash-poor start-ups. But because SEC and FASB rules are messy and evolving, prepare your company, and help yourself, by outsourcing the job of staying on top of the rules to a certified expert. Your corporate lawyers can help you with this, but it is a good idea to get an objective view from someone other than your outside counsel, _especially if your lawyer is also on your board_ (as was the case at Brocade). One good thing about SOX is that it has spawned an entire industry of lawyers and accountants who only consult on compensation.

*7) Get a second opinion.* Even after you’ve done this, get a second opinion from another compensation consultant or from another law firm. Trust us, this is as important as getting a second opinion from a doctor. A third view (yours + 2 consultant opinions) will reduce the risk of any debate devolving into a “he said – (s)he said” contest should your compensation policy ever come under scrutiny.

*6) ‘Your Board,’ is really the Company’s Board.* This is as it should be. As events at Brocade demonstrate, when a management policy is called into question and the resulting controversy has the potential to damage the company as a whole, if you are an executive with management responsibity (even a “founding-CEO”) you cannot expect ‘your board’ to place your welfare ahead of the welfare of the business. (Brocade’s board knew of the backdating, but forced out Reyes when the flack hit the fan.) This is why it is important to have experts who are independent of the board retained to assist you early on.

*5) Ignorance is not an acceptable defense.* It _might_ work in court, but if you ever want to be considered a competent business person again, it won’t serve you in the long run. When you bear a title like founder, or CEO, or Chairman of the Board, it means you’re in charge –you’re supposed to know what’s going on!

*4) An opinion letter from a lawyer is not a get-out-of-jail free card.* You paid for it. As we said above, you can add to your ad hoc “insurance policy” by getting more than one opinion, but no stack of lawyer’s letters can indemnify you from a prosecutor’s curiosity. And while it might seem unfair, prosecutors rarely go after thought leaders (or other lawyers). They go after those who _execute_ policy, and that means executives.

*3) You are a steward of your investors’ money. Respect their intelligence in this choice.* One of Reyes’ defense arguments is that investors wouldn’t care that he was dolling-out non-cash compensation, because it wouldn’t have an impact on the company’s earnings, and therefore, the stock price. Thus, he didn’t need to tell them about the backdated options. The Judge disagreed, saying that at a minimum, Reyes should’ve given investors the opportunity to decide for themselves since it was their money.

*2) The cover up is _always_ worse than the crime* — and often much easier to explain to a jury. If Reyes was confident that investors wouldn’t care about non-cash expenses for ‘in-the-money’ options, why did he need to manufacture dates to make it look like the options were ‘at the money’ on the day of the grants? Just don’t do it. When you make a mistake, acknowledge it and make amends.

And the #1 Lesson from Greg Reyes’ criminal fraud trial comes straight from the mouth of New York’s former ‘top cop’ and current Governor Eliot Spitzer:

*1) “Never talk when you can nod, never write when you can talk, and never, _ever_, put anything in an email.”*

5 Comments

Raul

As time goes by, I’m still waiting for other execs to go down in flames as Greg Reyes did, but nothing is happening. Some execs are paying SEC fines with no acceptance of guilt and walking away. I don’t want to name names, but just look at some of the semiconductor companies that where the most aggressive about stock option compensation and backdating. I’m thinking of one particular CEO of an IC company that was VERY vocal about his opposition to stock option expensing. He just paid a fine and he’s done. So I’m not sure why Greg Reyes is the guy that stands out in this crowd. I didn’t even know who he was until the trial came up.
So I have to wonder, why Greg? Why only Greg so far? The only other person to go down on this has been also from Brocade. So why so much focus on that particular company? Did all the other companies not change the dates on the grants? I mean, I thought that is what backdating stock options is all about. So why not prosecute them?
Last time I checked, our constitution supposedly guarantees to every citizen equal protection under the law. So I don’t understand this theory of making examples of people, why is it OK to selectively prosecute?

carleen

Hi Seth, thanks for your comment. I don’t think Spitzer was trying to encourage bad behavior, or secrecy. I suspect he was playing Devil’s Advocate (in a way that only the most provacative lawyers can) to prove a point. He’s really saying you *should not* try to cover your tracks, such as email your staff to shred documents, or email your staff to backdate stock options. But yours is a useful and interesting perspective. Best, Carleen}

sethx1138

I don’t agree with #1. It should read “Be honest and ethical. Talk, write, and email as much as possible.”

If you are honestly trying to follow the rules (even those as capricious as SEC and FASB regulations) it would seem that you would want as much documentation as possible showing that you are obeying the law. I admire Eliot Spitzer, and I’m surprised that he (and Found|Read) is giving advise on how to cover ones tracks.

To many it sounds crazy, but I still believe that you can run an aggressively competitive company and be ethical.

I’m doing it here in Mexico, of all places.}

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