Ex-Enterasys exec loses appeal bid

Chained at the ankles and wearing a shirt from the Strafford County Department of Corrections, where he was being held, former Enterasys Networks chief financial officer Robert Gagalis finally got his day in court to make his case that he had been caught up in a corporate “history of evil” and that he was kept off the stand during his 2006 trial because his former attorney didn’t want to incriminate a higher official who was represented by the same law firm.

It didn’t help.

On July 21, U.S. District Court Judge Paul Barbadoro, after a two-day evidentiary hearing, flatly denied Gagalis’s chance to appeal his conviction and 11-1/2 year sentence for securities fraud. In fact, Barbadoro told Gagalis that it would have been “disastrous” if he had been allowed to testify in his own defense.

“You would have been destroyed,” the judge told the former executive.

After a six-week trial in 2006, a jury convicted Gagalis and three others of conspiring to inflate revenue at Enterasys during the 2001 spinoff of Cabletron, which was once the largest employer in New Hampshire. But in an unusual plea bargain, Gagalis and the others waived their right of appeal – a move that Gagalis’s former attorney said was needed because of the risk that the government might successfully appeal Barbadoro’s decision to user older, more lenient sentencing guidelines.

Barbadoro firmly rejected the theory that the ex-attorney, James Rehnquist, had a conflict of interest because his firm also was representing an executive from Cabletron Systems, the Rochester firm that spun off Enterasys in 2001. In any case, said Barbadoro, that conflict did not cause any miscarriage of justice that would reverse Gagalis’s agreement to waive his appeal rights at his sentencing, nor was it the reason that the CFO didn’t testify in his own defense.

Gagalis, two years into a 11-1/2 year federal sentence for securities fraud, admitted that it was “my decision” to withhold information from auditors in crucial investment deals.

In those three-corner deals, Enterasys invested in shaky companies that used the money to buy Enterasys’s products through distributors. In December 2006, a federal jury agreed with prosecutors that Enterasys was in essence buying its own product and booking it as revenue without disclosing what was really going on.

“Paying somebody to take it is not revenue production,” summed up Barbadoro.

“Do I see that now? Yes, I see it. But what was important was what I saw then,” Gagalis replied.

But Gagalis said he was assured by Eric Jaeger, a former Cabletron executive vice president and attorney, that the deals were perfectly legal, because it was Enterasys – not the distributor – that was at risk. Jaeger is now a defendant in a civil securities fraud case brought by the Securities and Exchange Commission based on his role in investment deals at Cabletron and Enterasys.

(Four defendants in the SEC civil case, including Gagalis, either defaulted or pleaded guilty. Charges against the remaining six – including former Cabletron chief executive Piyush Patel and Cabletron CFO David Kirkpatrick — were dismissed once, then reinstated. Prosecutors are scheduled to appear in federal court in Concord on Aug. 18 to explain why they shouldn’t be dismissed again.)

Gagalis also said he “had no knowledge” that in many of the deals, the amount invested was almost exactly equal to the amount purchase.

There was no need to tell auditors “because there was no controversy. I was confident of the decision not to collapse them,” said Gagalis. It may seem secretive to withhold information from auditors in retrospect, he said, but companies don’t have to share every detail with their auditors.

Gagalis said he was wary of the auditors because of criticisms by Cabletron officials – including Craig Benson, Cabletron’s co-founder — that they were “nit-picky.” At the time, Benson was no longer an executive of the company but only served on the board, although he “seemed to pull the strings,” said Gagalis.

Gagalis — who Rehnquist said participated in his defense more than any other client – testified that he was convinced to abandon a defense that the company’s “history of evil” led to the fraud. But he only “reluctantly acquiesced,” although he added that he would periodically send news articles about other fraud investigations at Cabletron and its spinoffs to Rehnquist “as my way of rebelling.”

Gagalis’ current attorney — Michael Artan — maintained that Rehnquist backed off the “evil” defense so as not to implicate Daniel Harding, who was represented by Rehnquist’s firm, Goodwin and Proctor. (Harding was never charged, criminally or civilly.) Harding left Cabletron by the time Gagalis arrived, but he was in charge of the investment deals.

During the entire first day of the hearing, Rehnquist – son of the late U.S. Supreme Court justice William Rehnquist – was on the stand, defending his defense against charges of inadequacy in front of a courtroom filled with Gagalis’s friends and family.

Rehnquist maintained that he never thought it was a conflict, claiming his firm had built a “Chinese wall” between the two cases, and said the whole issue was raised as a “completely baseless threat by (Assistant U.S. Attorney William) Morse” to get him off the case. Barbadoro said he agreed with Rehnquist and chided Morse for raising it so strongly without bringing it to the court.

“I was trying to avoid the situation we’re in now,” Morse said.

“But it made it more likely that we are in the situation we are in now,” Barbadoro said.

Rehnquist’s contention about Gagalis’s possible testimony was bolstered by Cathy Green, the local defense attorney who was retained by Gagalis before Rehnquist came on board. While Rehnquist was the lead counsel, Green played an important role and would have questioned Gagalis should he have taken the stand. Green – who had no conflict – said she also thought Gagalis should not testify.

“Mr. Harding didn’t play any role in any of my recommendations and decisions,” she said.

‘Your day in court’

Despite Rehnquist’s fear of putting Gagalis on the stand two years ago for being “nervous,” the former CFO seemed relaxed and confident during his questioning on the second day of the hearing, sometimes interrupting Barbadoro to clarify his statements or state his position.

Gagalis started off the day by summarizing some 22 deals Harding was directly involved in, or were put together under him.

When Gagalis was confronted with the accusation that he ordered a key document backdated in order make sure some dubious revenue was booked for a quarter, he replied firmly, “It was a lie.”

Gagalis denied that it was more important that Enterasys exceed revenue expectations in its first quarter as a public company. That pressure also existed in five previous quarters where revenue was eventually restated, when Enterasys was still under Cabletron.

“It was no more critically important than any other quarter,” Gagalis said.

Indeed, he said, it was actually less important at the end of September 2001, a few weeks after the September 11th terrorist attacks. At that time, falling a few million dollars short “would not have impacted” the stock price, he said.

Gagalis continued to maintain that his “evil” company defense would have helped his case, because it would have shown he, newly hired to the company from Fisher Scientific shortly before Enterasys was spun off from Cabletron, would have naturally deferred to those who have a long history of approving such deals.

“I put a lot of reliance on them. I was new to the company, spent very little time on investment transactions,” he said.

It was only later, in an internal investigation in which Gagalis participated, that many of these deals were restated and it “dawned” on him that they should be transparent.

Artan contended that Gagalis was not fully advised that he could appeal his case, charging he had an inadequate defense based on a conflict of interest.

Rehnquist, however, denied that there was any conflict of interest concerning Harding. Rehnquist maintained that he was acting in the best interests of his client.

“It would have been suicidal to put on a defense that the real bad guys weren’t in the courtroom,” Rehnquist said.

But in the end, Barbadoro was so convinced that there was no conflict, he continually interrupted Artan with questions while he was trying to present his closing statement.

Saying that the “jury got it right,” Barbadoro added that the idea that Gagalis could have gotten a deal if he could somehow implicate higher-ups “doesn’t have any bearing in reality” and that the charge that Rehnquist backed off a defense theory was “not frivolous but not plausible either.”

He also dismissed as “not persuasive” Artan’s argument about why Rehnquist didn’t advise Gagalis – when he was waiving his appeal rights during sentencing — that the former CFO could use the conflict-of-interest argument itself as grounds for an appeal.

Rehnquist, Artan said, was reluctant to do so because he didn’t want to further highlight that conflict.

The real reason, said Barbadoro, was that any appeal risked at least doubling Gagalis sentence under newer sentencing guidelines, guidelines that Rehnquist called “hideous”. Waiving his right of repeal, so as to preserve the judge’s decision to use older sentencing during the trial was “the best decision he made during the whole trial” and “incredibly correct advice.”

At the same time, Barbadoro said that the government sought a harsher sentence, and he probably would have given Gagalis a shorter sentence had he not cut a deal with prosecutors.

Artan said he was “disappointed” and would consider an appeal.

The judge did say that Gagalis testified “sincerely,” adding: “I don’t think you are evil or even dishonest. You are just not accepting reality that you are guilty of crimes.”

He added that he heard the case partly out of “compassion” because Gagalis didn’t have “closure” because he never testified.

“You needed to have your day in court, and I wanted to give it to you,” he said.

Bob Sanders can be reached at bsanders@nhbr.com.