Greg Reyes' Day In Court: The Verdict

Discussion:
As many of you will have heard by now, Gregory Reyes, the 44-year-old former CEO of storage area network company, Brocade Communications, was convicted yesterday in federal court on 10 counts of securities fraud for backdating stock options he gave to his employees between 2000 and 2004.

While the official verdict is in, the pundits’ analysis of why the jury settled on finding Reyes guilty is just beginning. There was damning evidence, but the case was far from clearcut. Options backdating is controversial. Plenty of academic minds disagree about whether it is significant to investors, and therefore, whether it should be of interest, at all, to government regulators.

But having followed the trial for all of its five weeks, and after interviewing Reyes’ critics and supporters, we at Found|READ believe a key aspect of the debate can be addressed by a specific question, one that is critical for all founders to ponder as their companies grow:

QUESTION: Is Greg Reyes’ conviction of securities fraud a unfortunate consequence of his ‘good’ leadership, or a just consequence of his ‘bad’ leadership?

Most people in Silicon Valley with whom I discussed the verdict today—even those who felt Reyes should have been convicted on some, if not all, of the 10 felony counts brought against him by the U.S. Attorney—said they were stunned by the jury’s decision to convict on all counts. And it was a diverse crowd, including: startup entrepreneurs, bankers, a few litigators not involved in the case, and some personal friends of Reyes and his family.

Those dismayed by the guilty verdict often noted that Reyes’ didn’t personally profit from the options backdating scheme at Brocade (an allegation that has been made in indicments against other CEO’s for similar backdating offenses).

As one of Reyes’ former employees wrote in an impassioned email to me this evening:

Says Rod Saunders: “Greg was one of the hardest working bosses I have ever known, he ask[ed] for a lot, he rewarded success and he led from the front. I am certain his only thought in distributing options was to do the best for his employees. If he would have been included in the option grants I could understand the ruling, but he was not. [Editor’s note: Reyes did receive his own backdated stock options, but never exercised them.]
“Employees in America will never understand the blow they received today. From here forward American capitalism will be [run] by MBA’s, not leaders. This verdict will only accelerate the flight of capital and capitalist from this country.”

Those on the other side expressed their belief that backdating cases (such as Reyes’) are not merely about the technicalities of accounting, or the unseemliness of self-enrichment. (Self-enrichment, it must be noted, is not a criterion for committing securities fraud.) More than any of this, says “Erik Lie”:http://www.biz.uiowa.edu/faculty/elie/, the University of Iowa professor whose “highly-acclaimed 2005 white paper”:http://www.biz.uiowa.edu/faculty/elie/Grants-MS.pdf first revealed that executives had cherry-picked historical dates for stock options grants, the “backdating scandals” that now touch more than 260 companies are a backslash against slack corporate morals and withered good governance in America’s public companies. In short, says Lie, they are a referendum on our current state of corporate leadership:

“It’s got to do with what the motive was in the first place for backdating, and the motivation in the first place was to reap some benefits without incurring the costs or the risks of doing so…That executives as these companies were so secretive about their [backdating] tells me that they at least suspected that this was not truly ethical, and might even have violated various regulations, either in house regulations [at their companies] or regulations under the securities laws.”

Saunders would say Reyes is the unfortunate victim of his good leadership. Critics of backdating, such as Lie, might say Reyes is a victim of his own bad leadership.

What do you think?

Either way, this precedent-setting criminal trial is an important cautionary tale for all founders. If you have the intention of taking your company public, pay close attention to the lessons in this drama—read more about these in our “earlier Found|READ post”:http://www.foundread.com/view/greg-reyes-day-in.

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