Jottings By An Employer's Lawyer

Saturday, July 22, 2006

HR in the Dock


Although most headlines following the first criminal indictment in the burgeoning back dating of stock options scandal read like this, Former Brocade CEO charged in options scandal, no HR executive should overlook that also indicted was Stephanie Jensen, who served as the Vice President of Human Resources for Brocade from 1999 to 2004. Recent corporate scandals have focused on accounting and finance, but given HR's role in the administration of stock options this has the potential for the first wide spread occasion where HR professionals may find themselves the target of civil and criminal actions.

Briefly, what is alleged to have happened at Brocade and perhaps as many as 2,000 other publicly held companies is that stock options were back dated to a time when the stock was at its lowest price, often guaranteeing an immediate gain when they were actually issued. It involved not only back dating the options, but in some cases falsifying other corporate records to reflect the incorrect dates, with the underlying problem being that it caused false financial reporting.

At least in the Brocade case it does not appear this was a quest for personal gain, but was seen as necessary to compete in the recruiting wars for talent. It doesn't take long to see the beginning of what could have been a real slippery slope:

  • It had to be done to help the company grow and compete;
  • Everyone else was doing it;
  • There was no personal gain involved; and
  • It didn't appear to really hurt anyone.

Whether the last part is true is something for the economists to debate (and I am sure they will in great detail) but there seems to be little question it did result in erroneous reporting of the company's financials. The SEC and the Department of Justice also contend it is a violation of both civil and criminal laws.

I can see the details laid out in the criminal complaint against Stephanie Jensen as sounding altogether too close to what many could imagine happening in their own company:

F. Brocade's Purported Stock Option Granting Process.

22. According to an August 2000 e-mail circulated by JENSEN and other documents, JENSEN and REYES purported to adhere to the following procedures and practices (among others) when REYES exercised his delegated authority to grant stock options to new hires: (1) stock options would only be granted to a person once his or her employment at Brocade actually commenced, whether in a full-time or part-time capacity; (2) the stock option grant would be subject to Committee approval of the Board of Directors, that is, approval by REYES acting on behalf of the Compensation Committee; (3) the exercise price of the stock options would be set on the date the Committee met; and (4) the exercise price of the stock options would be equal to the market value of Brocade's stock on the grant date, that is, the date the Committee met and approved the stock options.

G. Brocade's Actual Stock Opting Granting Process.

23. According to witnesses who worked within Brocade's HR department, Brocade did not actually follow the above described process. Rather, REYES and JENSEN often waited until the end of the fiscal quarter before granting the stock options. JENSEN's staff routinely printed out the historical closing prices for Brocade's stock and highlighted the low dates during the quarter. They provided the historical pricing information to JENSEN with a draft of the Committee meeting minutes approving stock option grants for the employees who were eligible for grants. JENSEN or her staff gave the historical pricing information to REYES with the meeting minutes. REYES routinely signed the meeting minutes and dated the minutes as if the meetings occurred on the highlighted low dates and the stock options were priced at the market value of Brocade's stock on those dates.

24. By June 2003, the above described practice for pricing stock option grants had become so routine that an HR employee prepared a memorandum describing the practice. The memorandum explicitly directs the HR employees to recommend a pricing date by printing out historical closing prices for Brocade's stock and identifying the closing price that is the lowest since the last pricing date. This memorandum was shared by lower level HR employees who helped implement the process. The above-described process continued into 2004.

According to the indictment some employees were given stock options actually pre-dating their interview with the company.

Obviously, the above at this point are just allegations and there are no doubt serious arguments that even if true, it may not violate any laws -- but when you are facing a potential sentence of twenty years in prison, a $5 million fine and a separate civil lawsuit seeking financial penalties from a government enforcement agency -- it brings the potential dangers of an HR job home.

HR is often called on to be the conscience of a company. Time may soon tell how well that mission has been accomplished.

UPDATE: The CEO of Brocade, Gregory Reyes, who was indicted at the same time as Stephanie Jensen, has now been found guilty of 10 counts of security fraud by a California federal jury. Ex-Brocade CEO Reyes guilty on all securities fraud counts. No trial date has been set for Jensen.


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