Thursday, January 17, 2008

fraud, theft and tax evasion by any other name

First Backdating Conviction Brings Prison Term and $15 Million Fine - Gregory Reyes, former CEO of Brocade Communications Systems was sentenced to serve 21 months in prison and pay a fine of $15 Million for backdating options granted by his employer. Sound harsh? What's a little backdating between friends? "Backdating", like "market timing" is a PR triumph of the white collar defense bar. Call it backdating if you wish, NY Times, but recognize that Reyes got what he deserved. Kudos Judge Breyer.

An option is a right to buy a stock at a specified exercise price for a specified period of time. Suppose the price of Brocade stock closes at $1/share on January 10 and $2/share on January 15. On January 15, Brocade grants Reyes an option to buy one million shares at the market price on the "date of grant". If this was handled properly, the exercise price is set at $2/share, Reyes receives no taxable income on the grant (although he will owe tax when he exercises at a profit) and Brocade, until recently, had no expense (for book income purposes) or deduction (for tax purposes) when it made the grant. So long as the exercise price was no less than the market price on the grant date, Brocade could, at that time, grant options with no immediate impact on its income (although accounting rules on option grants have changed recently). If Brocade made a grant of an option to purchase one million shares on January 15, at an exercise price of $1/share when the market price was $2/share, Brocade would have reported an expense of over a million dollars in its financials and Reyes would have received taxable income on grant. Now suppose that on January 15 Brocade grants an option to purchase a million shares at fair market value, but Reyes fiddles with the records so that the option actually granted on Jan 15 is recorded as a Jan 10 grant. His exercise price becomes $1/share at a time when the market price has already jumped to $2/share. By fudging the grant date he's not only causing the company to under report compensation expense, he's also giving himself a much more valuable option (essentially stealing from his own shareholders) and ducking taxes to boot. Backdating sounds a lot nicer than theft, fraud, tax evasion - Times, why are you a sucker for these polite euphemisms like backdating and market timing?

Account of CIA Tapes is Challenged - Chairman Hoekstra is summarizing one side of the story here as he prematurely runs to the press with the report that Jose Rodriguez, former CIA head of clandestiny, acted contrary to directions when he destroyed CIA torture tapes. As Good As News has been poking some fun at Rodriguez, but the prediction here is that Rodriguez received general advice, possibly from many sources, that it would be a good idea to preserve the tapes, but no clear order to do so. He also received no clear direction or authorization to destroy the tapes, but he may have received legal advice that destruction of the tapes would not be illegal if they were not evidence of a crime and if they were not relevant to any pending legal proceeding. Both of these ifs loom large today. The legal opinions of Dr. Yes on the scope of lawful interrogation techniques are discredited, and interrogators might theoretically be vulnerable to criminal prosecution. The CIA's reading of the scope of a the 9/11 inquiry now seems disingenuous, at best. At the time he destroyed the tapes Rodriguez probably took some comfort from the official White House and CIA position on both of the "ifs" - torture was OK, not criminal, and when investigators asked for records they did not mean to include tapes.

Listen to what Robert Bennett says here, not Committee Chair Peter Hoekstra. Hoekstra has to run for office every two years, grabbing publicity with preliminary information is like breathing. Bennett is an advocate, not a neutral party, and he will put the best possible face on the facts, but he is also an extremely bright and capable lawyer who won't intentionally lie to the Committee, or even the press, because, among other things, he knows it will backfire.

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