Enterasys judge puts shareholder loss at $97m

The securities fraud perpetrated by four former Enterasys Networks executives cost shareholders some $97 million, US District Court Judge Paul Barbadoro ruled Thursday.

That means that Barbadoro – if he follows sentencing guidelines – will be handing out long jail terms when he sentences the defendants. Sentencing is scheduled to take place today.

While stockholders’ loss is not as great as the $144 million claimed by the government, the ruling only knocks about two years off the maximum 33-year sentence prosecutors are seeking for Robert Gagalis, the firm’s former chief financial officer.

Prosecutors were seeking 30-to-33-year sentences for Gagalis and David Boey, once sales director of the company’s Asian-Pacific division, and 24 to 30 years for Bruce Kay, former vice president of finance, and Robert Barber, who served on the company’s investment team.

Defense attorneys, on the other hand, say their clients should be sentenced to less than five years, which is the cap agreed to by those who pleaded guilty in exchange for their testimony, including former CEO Enrique “Henry” Fiallo, who is scheduled to be sentenced in October.

At NHBR Daily deadline, Barbadoro hadn’t yet ruled whether the tough sentencing guidelines apply to a conspiracy to inflate revenue when the Rochester-based Cabletron Systems was spinning off Enterasys in 2001. Those guidelines went into effect in November 2001. But the judge did state several times that it appeared that conspiracy continued until February 2002, which would seem to indicate the newer guidelines would apply, at least to some of the conspirators.

Barbadoro told the defendants and their families that there are other factors besides loss to be considered in sentencing, and that he might depart from the guidelines altogether, since they are not mandatory.

But the amount of loss would be key to any decision. Under the new guidelines it could mean the difference between spending two years in prison and 30 years. The court spent a day and a half debating the loss involved, with dueling expert witnesses.

The prosecution’s witness, Laura Stamm, defended her report – which cost the government about $150,000 to prepare — as conservative, especially given the $1.3 billion drop in value after Enterasys executives revealed they had discovered another copy of a contract that would have prevented the company from recognizing revenue.

The defense expert — Bala G. Dharan — said that the stock was going down anyway, and there were other factors in the announcement that caused the stock to plummet, including the announcement of a formal Securities and Exchange Commission investigation — which at the time was not related to anything the defendants did – and Cabletron’s delay in spinning off Aprisma as an initial public offering. If you take these other factors into account on such a volatile stock, he said, the extra drop could have been no more than a random fluctuation.

Therefore, no loss could be attributed with any confidence to the defendant’s fraud, said Dharan.

But Stamm said she took all that into account, and it was the “likely probability of fraud” in the discovery of a secret contract that caused $144 million of that drop in value.

Barbadoro questioned both experts closely. At one point he challenged Dharan to refute a Fifth Circuit Court of Appeals method of deciding on stockholder loss. At another point he put both on the stand and let them challenge each other’s methods.

In the end, he said, “I believe her.” And while he lowered the loss estimate to the low end of Stamm’s range, he said he was just being a little more conservative.

“It would be ludicrous to suggest that shareholders didn’t lose tens of millions of dollars,” Barbadoro said.

The court was meeting into Thursday evening to discuss which set of guidelines to use in the sentencing. Though the focus of last year’s six-week trial was on the quarter that ended Aug. 31, 2001, before the new guidelines apply, there were a few fraudulent deals in the following quarter that prosecutors brought up. Prosecutors also contend the defendants, by their mere silence during the February 2002 partial disclosure, were continuing the conspiracy to misrepresent the company’s finances. Defense lawyers said that the other deals were part of another conspiracy, not the one presented to the jury that convicted them.

In a switch from the original schedule, Boey is expected to be sentenced first today, followed by Barber, Kay and Gagalis. Barbadoro said he would finish the sentencing on Saturday, if necessary, because of another trial coming up next week.

Check with NHBR Daily for updates. – BOB SANDERS