SEC Gets Formal With Brocade

The Securities and Exchange Commission (SEC)s probe into how Brocade Communications Systems Inc. (Nasdaq: BRCD) accounted for stock options from 2001 to 2004 has gone from an informal inquiry to a formal investigation.

The SEC notified Brocade of its decision to formally investigate late Thursday afternoon. The news is hardly surprising, considering a series of admissions the company made since its CEO Greg Reyes stepped down in January (see Brocade Switches CEOs, Restates ).

Brocade first revealed the SEC and U.S. Department of Justice were conducting a joint investigation last month (see Brocade Being Investigated). As a formal investigation, the SEC now can issue subpoenas for information. Previously, the SEC asked for voluntary information.

Brocade's share price closed even at $4.03. But that's a far cry from the $8.17 price Brocade shares carried in December, shortly before the departure of Reyes.

Brocade reported disappointing sales last quarter, losing market share to major rivals Cisco Systems Inc. (Nasdaq: CSCO) and McData Corp. (Nasdaq: MCDTA). (See Brocade Bungles Quarter, McData: 'We Gained Share', and Cisco's Storage Climbs.) But the mess over its stock options accounting have overshadowed everything else.On May 16, Brocade said it could not rely on documentation used to support the recorded measurement dates for stock options granted from August 2003 through November 2004. In addition, it said it failed to properly account for the cost of stock options for certain employees from 2001 to 2004. Brocade is restating financial statements for 2002 to 2004. Last week the company said it would delay filing its 10-Q financial report for last quarter (see Brocade to Delay Filing Form 10-Q ).

The primary issue is that Brocade failed to follow its guidelines by allowing certain employees to continue vesting in their stock options after they were on leave of absence for more than three months.

The first hint at trouble came when Reyes resigned on the same day the company announced the results of an internal audit focusing on options compensation. Mike Klayko, who joined Brocade in 2003, was immediately promoted from sales VP to replace Reyes as CEO.

Reyes remains on Brocade’s payroll as a $910,000 a year consultant, but company executives say he’s not providing services for his fee, leading to speculation they might go to court to avoid paying him (see Brocade Blasts 'Consultant' Reyes).

— Dave Raffo, Senior Editor, Byte and Switch0