The Reyes Conviction: Backdating and the Differing Attitudes Between Delaware and the Federal Government

It was announced today that a jury convicted Gregory Reyes, the former chief executive of Brocade Communications Systems, of ten counts of fraud connected to the backdating of stock options.  The WSJ story is here.  The judge still has to decide a motion to dismiss so the case could yet have a different finish.  Nonetheless, we note the difference in the treatment of backdating at the federal level, as evidenced by this verdict, and at the state level, as evidenced by the Delaware decision in Desimone.  As the court in that case noted: 

• ""By contrast, in a situation where directors are expressly permitted under the terms of a stockholder-approved option plan to issue below-market options, it would be well within the realm of business judgment to choose to issue all options to a set of similarly-situated employees at a uniform strike price reflecting the stock's low point for the quarter.  But even in that situation, a director could not, with impunity, secretly backdate the option grants while falsely representing that they were made at fair market value on the dates of the grants or account for them as such."

In other words, go ahead and backdate, just don't make an affirmative misstatement about the fair market value of the options.  One suspects that while Reyes was convicted of fraud in federal court, a derivative suit alleging the same behavior in Delaware would have been dismissed.  To the extent that Delaware courts find that backdating is consistent with a board's fiduciary duty, it may encourage future federal intervention in defining the duties of directors.