Enterasys trial enters final stage

Enterasys Networks’ former chief operating officer, Jerry Shanahan, will not take the stand in the month-long securities fraud trial of five former executives, his attorney announced Tuesday, meaning that none of the defendants will testify or offer witnesses to the jury.

Instead, the defense was being made solely for the eyes and ears of U.S. District Court Judge Paul Barbadoro in Concord, as attorneys — in a flurry of last-minute filings and oral arguments – tried to persuade him to dismiss some of the counts, or instruct the jury in their clients’ favor.

The five executives are accused of lying to auditors about certain deals in order to inflate revenue during a crucial quarter in 2001, when Enterasys was spun off from Cabletron Systems, a Rochester-based company that was once the state’s largest employer.

Barbadoro appeared to throw out most of the efforts to dismiss, which were primarily technical in nature. Since the defendants are accused of numerous counts, each required a close reading of the law to assess how criminal liability applied in each count.

“There is abundant evidence they acted with criminal intent,” said Barbadoro of the defendants. But that doesn’t mean they broke the specific laws that they are accused of, he added.

The judge said he found Shanahan’s “I couldn’t have killed him because he was already dead” defense as the most intriguing.

The judge wasn’t referring to a person but a $3 million deal with Tech Data Canada, an Enterasys distributor, in late August 2001. Shanahan allegedly removed two problematic terms from the deal, including a clause that would exempt Tech Data for paying for any hardware that it didn’t sell in 90 days. Shanahan than included the clauses in a side e-mail that the auditors weren’t aware of.

But Shanahan’s attorney, Andrew Good, noted that a third clause that wasn’t removed also would have prevented revenue recognition — that Tech Data could have returned everything if the deal wasn’t signed by Oct. 31, which it wasn’t. Even if Shanahan intended to conceal the terms from the auditors — which his attorney denies — the revenue shouldn’t have been recognized. But it was improperly recognized in that crucial quarter anyway, according to the auditors.

Barbadoro said he was inclined to instruct the jury that Shanahan was “incapable of defrauding anyone because the deal was already dead,” but not actually to throw out the count.

Other defense arguments included:

• William Cintolo, attorney for David Boey, the head of sales in the Asia Pacific region, reiterated his argument — a mirror image of the one put forth by Good. The government accused Boey of altering a $3.9 million deal with another distributor, Ariel International, also by removing two problematic terms for revenue recognition, only this time after the quarter ended, backdating the revised document and adding the terms in a side letter.

Cintolo maintains that revenue should have been recognized with or without the terms. Those in the front office panicked and ordered Boey to change the deal, but no harm was actually done. Barbadoro also seemed intrigued by this idea, but wouldn’t dismiss any charged based on it.

• Bruce Kay, former vice president of finance, urged that the contract be changed, but attorney Bruce Singal said that the deal was legitimate. He added that the auditors were part of that panic, so shouldn’t have testified as experts into the true nature of the deal. Since the prosecution didn’t obtain any independent auditors, the jury should be told to disregard what the auditors said. Barbadoro didn’t agree.

• Even if Robert Gagalis, the former chief financial officer, concealed information from auditors, the auditors sign off on annual, not quarterly, filings with the Securities and Exchange Commission, said his attorney James C. Rehnquist. Since the quarterly filing was allegedly falsified and it came to light before the annual statement was filed, there was no violation. The prosecution, however, argued that auditors are always preparing for the annual statement, and the language in the law also could apply to quarterly statements.

Rehnquist also argued that stockholders weren’t hurt by the inflated stock price, therefore some laws that require harm wouldn’t apply. But prosecutors argued that those who unknowingly bought at the inflated price were harmed when the stock crashed. Barbadoro added that short sellers also were harmed in the short run.

• Bob Barber, a former Cabletron executive who was a consultant on the Enterasys investment team, perhaps put forward the least technical argument. He’s charged with putting together so-called “three-corner deals” in which Enterasys would invest in shaky companies, which would immediately take that cash to buy Enterasys products through a distributor. The company would then conceal from the auditors that product sales from those investments were included in its revenue.

Barber’s attorneys said that he didn’t even work for the company at the time, and had nothing to do with reporting revenue. They said he was involved in the deals because of long-term opportunities for Enterasys, not to inflate revenue.

Barbadoro, clearly irritated at the number of legal arguments he had to consider in a short time, lashed out in all directions. He threatened to hold the Securities and Exchange Commission in contempt for not producing documents sought by the defense.

“If they want a battle, I’ll give them a battle,” he said in the morning, but the documents were procured by the afternoon.

Then he called the defense on the carpet for “misleading” him in presenting a legal argument. Defense attorneys were so zealous in advocating for their clients that they weren’t being open with the court, he said. He said the case was extremely frustrating and criticized “the quality of the interactions between bench and bar.”

Reluctantly, he set aside Wednesday for both sides expect to continue to hash out legal arguments. On Thursday jurors are expected to spend an hour reading exhibits offered by the defense, to be rebutted by two prosecution witnesses. Then they will listen to about eight hours of closing statements over two days, followed by complex instructions by the judge, before beginning their own deliberation on Friday. – BOB SANDERS

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