“On May 14, 2008, the Securities and Exchange Commission filed a civil action in the United States District Court for the Central District of California alleging that William J. Ruehle and current or former officers of Irvine, Calif.-based Broadcom Corporation, engaged in a scheme to backdate stock options at the company from 1998 to 2003. The Commission’s action was stayed at the request of the United States Attorney’s Office pending the criminal trial….On December 15, 2009, after the close of the evidence in Ruehle’s criminal trial, the Court entered a judgment of acquittal in Ruehle’s favor and dismissed with prejudice the stock option backdating indictment…and discouraged the Commission from proceeding further with its action.” —U.S. Securities and Exchange Commission litigation release, Feb. 4, 2010
In Mr. Ruehle, You Are a Free Man—A Broadcom Saga, Bill Ruehle tells his own surreal story of a mild-mannered and cerebral Harvard-trained CFO in the fight of his life against a headline-seeking prosecutor.
By 2006, America had digested Enron and the dot-com bust, and was getting back to business. Then along came a Wall Street Journal article on an obscure academic research paper, “On the Timing of CEO Stock Option Awards,” written by Erik Lie, a finance professor at the University of Iowa. Lie’s research showed that certain option grants dated from 1996 to 2005 had the benefit of hindsight, but left open the question of whether the selection of grant dates was due to deception or discretion. The future of hundreds of companies and thousands of executives would hinge on that very point, as would Ruehle’s criminal trial.
In 2010, Lie told New York Times’ Dealbook reporter Peter Lattman, “I never expected my study would lead to anything. At the time we published the paper, it wasn’t clear that regulators would view the activity as illegal.”
Backdating wasn’t limited to poorly governed start-ups. Among the 220 companies that publicly disclosed option accounting issues were such iconic names as Apple, Alcatel, Clorox, Dean Foods, Gap, Home Depot and Microsoft. Although none were charged criminally, some of their executives, like Apple CFO Fred Anderson, were forced to settle with the SEC for sums as large as $3.5 million.
It was not a very good time for executives to be involved in unfair compensation practices, and the country was not amused. In early 2006, even the Republican-appointed SEC Chairman Christopher Cox declared regulatory holy war: “Options backdating…deceives investors and the market as a whole about the financial health of companies that cheat in this way….It is poisonous….The SEC is committed to bringing it to an end nationwide.”
Sen. Jim Bunning (R-KY) added a thoughtful postscript—disregarded by both his Senate Banking Committee colleagues and the SEC—that turned out to be prophetic: “Although Chairman Cox’s remarks are well-taken, many would likely oppose his blanket statements regarding backdating’s ‘poisonous’ nature. Interestingly enough, even Chairman Cox acknowledges that back- dating, in some circumstances, is perfectly legal.”
The opportunity to make headlines would soon spur Capitol Hill’s solons into action, as Senate Banking Committee Chairman Paul Sarbanes, co-author of the Sarbanes-Oxley Act of 2002, made clear in 2006, saying, “It is now official that no issue in the 72 years of the Commission’s history has generated such interest” as stock options backdating.
The ramification among working-level attorneys at the Department of Justice and accountants at the SEC looking to pounce on the new white-collar crime phenomenon was predictable: “Wanted: Backdaters” was like a neon sign flashing in the mind of every DOJ regional attorney across the land.
In fact, regulators were so distracted by the sheer volume of cases, it has been speculated that more obvious targets—such as Bernard Madoff and Allan Stanford—went unnoticed. This was confirmed in 2012 by an NYU Law School report, “Scandal Enforcement at the SEC” (Choi, Pritchard, Wiechman): “As the level of media scrutiny of option backdating increased…the SEC pursued more marginal investigations into backdating as the media frenzy surrounding the practice persisted at the expense of pursuing more egregious accounting issues.”
By the time the uproar subsided late in 2009, as Bingham McCutchen partner (and former assistant attorney general for the DOJ) Nathan J. Hochman posted on Forbes.com, “The government’s stock-option charging decisions became a wheel of misfortune. There was simply no telling which company would be sued or which individual would be prosecuted. Of the over 200 companies and 1,000 individuals with options problems, only 22 individuals have been charged criminally by the Department of Justice.”
Ultimately, only five executives received criminal sentences. The vast expenditure of resources resulting in only five criminal convictions seems lopsided, to be sure. But also missing from the sanctimonious hand-wringing about executive greed was a thoughtful debate about whether regulations that were applied differently in an earlier, less litigious time were being applied indiscriminately in 2006 in order to gain convictions. It was an omission of enormous significance to the trial of William Ruehle: “Most accounting experts will admit that different interpretations of option accounting rules existed prior to 2002,” he writes. “But four years later, by 2006, the government’s auditors and lawyers started to interpret the old rule APB 25 in a very strict way and looked back several years to see that paperwork matched the newer, stricter interpretation.”
And that would change everything. Brocade and Comverse were two of the highest-profile California cases in which executives received criminal convictions. Brocade’s CEO, Greg Reyes, was convicted on nine counts of fraud (he served a sentence of 18 months and received a fine of $10 million, according to the San Jose Mercury News). Comverse’s CEO, Jacob “Kobi” Alexander, felt his chances were better as a fugitive and in 2006 he escaped to Namibia, where he resides today (he also ultimately settled civil charges with the SEC for $46 million in 2011). The sensational news of Alexander’s flight from justice sent an urgent signal across the U.S. Attorney network that it was open season.
Assistant U.S. Attorney Andrew Stolper of the Central District of California was barely eight years out of USC’s Gould School of Law and had already racked up an impressive résumé taking down small-time business bad guys (he participated tangentially in the Enron case). But he had no backdating trophies. When Broadcom’s internal option grant investigation revealed errors, Stolper jumped on the case that he apparently thought would crown his budding legal career.
Two remarkable UCLA engineers who saw the promise of broadband communications started Broadcom in 1991. By 2000, the company had grown to over $1 billion in revenues. Ruehle joined the company as CFO in 1997, when the company was still run by CEO and co-founder Henry Nicholas, who exerted nearly hypnotic control over all operations. Nicholas’s grasp of the business was superior, and it was known that if he asked a question, he knew more about the area than you did. And no one argued. In this environment, Nicholas’s entrepreneurial approach extended to options grant practices—and since Nicholas and co-founder Henry Samueli were the board’s entire options committee, this was not very surprising. Prior to the passage of Sarbanes-Oxley, CFOs did not report to the board, nor did they have the kind of independence from the CEO they enjoy today.
These factors account for some the challenges Ruehle describes during this period. “Bottom line,” he writes, “there really wasn’t a lot of attention paid to the accounting of options for all the known reasons, and as the company was growing so fast, certainly at the time the deeper documentation was deemed unnecessary, which was part of our defense. During the years that were charged, 1998 to 2003, there were notions that these were principles subject to interpretation and discretion rather than hard and fast rules.”
In his calm and self-effacing manner, Ruehle isn’t looking for sympathy or even empathy for the ordeal of his three-year criminal trial, nor does he make himself out to be any kind of hero due to his vindication. In fact, like the main character of Franz Kafka’s The Trial, Joseph K. (who also happens to be a CFO), Ruehle seeks only to show the reader what it took to maintain sanity while dealing with a judicial system trying to destroy a person for something he did not do.
What was not in doubt, even to prosecutors, was that Ruehle ever acted out of any desire for self-enrichment. After the Broadcom IPO, he had exercised only 15,000 options out of more than two million in-the-money vested options. Since this made for a much weaker case, the aggressive assistant U.S. attorney needed extra ammo to get any of the 16 counts against Ruehle to stick.
That’s where the plot thickens.
Missing the usual pegs on which to seek a conviction, Stolper, according to the trial record, intimidated witnesses until they provided the right kind of testimony, his kind.
As reported in detail in Mr. Ruehle, You Are a Free Man, motions were to be submitted prior to closing arguments, and Ruehle’s defense attorney, Richard Marmaro, and his team filed the following details of Stolper’s prosecutorial misconduct: “There is now clear and convincing evidence that the government in this case: attempted to dissuade a witness from testifying on Mr. Ruehle’s behalf; threatened an immunized witness with perjury prosecution if he testified consistently with prior sworn testimony [that the witness had made to the SEC]; suggested how defense and prosecu- tion witnesses should testify [coached one witness 24 times on her testimony]; pressured two witnesses into dubious and invalid plea agreements [relating to a trumped-up drug-related charge against Broadcom co-founder and former CEO, Henry Nicholas, which was later dropped due to defects in the prosecution]; leaked information related to an ongoing grand jury investigation in an effort to gain cooperation [leaked to the WSJ]; discussed adverse employment consequences for witnesses who did not cooperate [spoke to the employer of one witness which resulted in her termination]; elicited false and misleading testimony.
“On the trial’s Rule 29 motion [if ruled in favor, it is an acquittal that cannot be retried]: Not a single witness has testified that Mr. Ruehle knew or believed that Broadcom’s financial statements were false or misleading in any way.
“The testimony has established that Mr. Ruehle repeatedly urged the finance department to openly discuss issues with the company’s auditor [E&Y]; Mr. Ruehle established that Opinion 25 was widely misapplied throughout corporate America, causing 220 companies… to restate or correct financial statements.”
‘The Truth Is Never Negotiable’
The robe worn by District Court Judge Cormac J. Carney concealed not just a professional football player’s build but also a wide receiver’s determination. Carney came straight from judicial central casting. As a UCLA undergraduate, he played wide receiver for the Bruins while racking up a 3.5 GPA. He then played one year of professional football before entering Harvard Law School. His court appointments ranged from one side of the political spectrum to another, from California Gov. Gray Davis to President George W. Bush.
When Judge Carney heard testimony about Stolper’s actions, he bristled. Toward the end of the trial, Carney even placed a gag order on Stolper, denying him a speaking role. Rather than limp to the finish line, Stolper apparently lost interest, as he simply stopped showing up in court.
On Dec. 15, 2009, the day after all final motions had been filed, the courtroom was standing room only—an overflow room had to be provided. Between prosecutorial misconduct, drug charges and billionaire indictments, the media frenzy was as sharp as it was guttural. At the start of the day, Ruehle wrote a note to his wife, Julie: “Need to stay focused. I am prepared to accept what- ever is decided today.” And Julie wrote back: “My hands are shaking….No matter what the judge decides we are grateful to him to have allowed the door to the truth to get unlocked. Thank God for Judge Carney. Thank God for the truth.”
Ruehle captures Judge Carney’s remarks – so eloquently spoken they would please our founding fathers – in his description of the final day of the trial:
“Judge Carney entered behind his bench, as always. He began by greeting all the attorneys for the government and for the defense. After the greeting, he declared he would read his decision into the record: “‘I heard all the evidence present at Mr. Ruehle’s trial….I now know the entire story of what happened….Based on the complete record now before me, I find that the government has intimidated and improperly influenced the three witnesses critical to Mr. Ruehle’s defense. The cumulative effect of the misconduct has distorted the truth-finding process and compromised the integrity of the trial. To submit this case to the jury would make a mockery of Mr. Ruehle’s constitutional right to compulsory process and a fair trial…. The lead prosecutor somehow forgot that the truth is never negotiable. The U.S. Attorney is the representative, not of an ordinary party at a controversy, but of a sovereignty whose obligation to govern impartially is as compelling as its obligation to govern at all, and whose interest, therefore, in a criminal prosecution is not that it shall win a case, but that justice shall be done…while he may strike hard blows, he is not at liberty to strike foul ones. I don’t think anything needs to be said further other than Mr. Ruehle, you are a free man.’”
Andrew Stolper remains an Assistant U.S. Attorney. On his personal website, he takes pride that his work for the DOJ has been featured in national headlines in publications such as The Wall Street Journal and The Los Angeles Times. It is ironic because today he has achieved some measure of fame—a Google search for “Andrew Stolper prosecutorial misconduct” will return over 8,000 citations.
Ruehle’s defense attorney, Richard Marmaro of Skadden Arps, heads up the firm’s West Coast SEC enforcement and white-collar defense practice. It is very possible that without brilliant defense counsel, despite his innocence, Ruehle’s memoirs might have been written from a prison cell.
Today, Bill and Julie Ruehle have started an enterprise consulting business, Ruehle CFO Advisory Services, LLC, that works with early- to mid-stage technology companies from internal controls to financial and business strategy.
Broadcom remains a global leader in semiconductor solutions in the communications industry and was ranked No. 344 on Fortune’s list of the top 500 companies in America, with revenues now nearly $8 billion. Samueli remains as board chair and CTO. Brocade is still a leader in enterprise data storage and networking. In 2011, it was ranked among Fortune’s top 100 companies to work for. Comverse had a more difficult time righting itself but was finally relisted by Nasdaq in 2011 and today is growing again, and supports a billion-dollar market valuation.
The final cost of Broadcom’s defense of stock options backdating was reportedly more than 120 million shareholder dollars.