New Twist on Reyes

So, ever since Greg Reyes was convicted on all 10 counts levied against him it seems that everyone (myself included) immediately chalked it up to a "well, he got what was coming to him" for screwing with the rules. I've been quoted on the subject many times over the last year, and have been pretty consistent in my position – if he did it, he deserves to pay the fiddler.

I'm not sure what it is within me that makes me a contrarian – even versus myself it seems – but now that everyone is ready to put him behind bars, I'm no longer so sure.

I was following the trial at a very cursory level. I know some of the participants, which kept me interested, and I also know that there are about 150 other companies with the same potential issues regarding options back-dating and securities fraud that were watching this case very closely. When the verdict came down I wasn't overly phased one way or another, except to observe the ripple effects to those other 150. But then an interesting thing happened a few days later.

I took my 5 year old to the barber on Saturday. He enjoys getting his hair cut simply because he knows he will get a pop if he powers through it, and while he hates the entire notion of the actual haircut by the 67 year old former marine barber, he loves a good pop more. Anyway, as Michael is in the chair, I was reading the paper. In a small paragraph in the business section I saw an article that said "Brocade CFO Indicted on Securities Fraud".

Here's where it gets interesting – part of the government's case against Reyes relied on the argument that Reyes effectively did what he did alone – without the knowledge of his finance department, and namely CFO Mike Byrd – they guy now indicted for knowing and doing all the things Reyes was accused of doing all by his lonesome. That made me curious, so I've been spending some extra time recreationally reading the court transcripts.

Note: I am not a lawyer, but I should be. I personally believe that Greg Reyes knew he was backdating stock options. I also believe that it is irrelevant in the grand scheme because A: it isn't a crime to do it – it's only a crime if you intend to defraud others by doing so, B: because since it isn't a crime, the government has an obligation to prove fraud and how investors got hurt (they didn't – investors apparently don't even put stock option expenses into their models – at least the ones who testified) and C: that while I personally don't agree with the rational behind backdating options – to allow your employee who has the option to make more money – it's not like the employee who makes the money isn't responsible to pay their fair/unfair share to the government in the form of taxes anyway.

So, for the sake of argument, let's say that I'm not commenting on the guilt or innocence of Greg Reyes in any way. What I was interested in was the role the government played in the prosecution. In light of the Duke (Nifong) fiasco where an overzealous prosecutor went way out of bounds because he believed he represented justice, the Mike Byrd indictment made the hair on my neck stand up. I have plenty more to research, but here's some interesting things to chew on.

From the official transcript – in the closing argument of the prosecution (Volume 20, pages 4041-4212) by Mr. Crudo:

"Where is the evidence that the defendant relied upon Mr. Byrd, Mr. Bossi, Mr. Canova, Mr. Blucher or anybody else in finance? Where is the evidence of any communications where anybody from finance told him you can backdate; go ahead. Put a date on there from a date in the past. You can do that. There isn't any. Now, Mr. Marmaro said yesterday that the finance people know the most. They know the most about what was going on. Now, that's totally contradictory to our theory. Our theory is that those people didn't know anything. Elizabeth Moore told you they didn't know anything. Now, the defendant called all kinds of people who didn't know anything about the stock option process. In fact, go back and look at your notes. Not a single person that they called knew anything was involved in the stock option process. Defendant could have called witnesses in this case as well. Doesn't change that it's our burden. You shouldn't hold us to a lesser burden because they didn't call somebody. But think about that. Elizabeth Moore says finance didn't know. Did you need everybody in the finance department to come and tell you that they didn't know? But take a look, when you look at those, the document that he showed you, which was Exhibit 2539, take a look at these two, take a look at 2526 and 2536. And those will show you that Mr. Byrd was deceived as well."

Mr. Byrd was the CFO then COO of Brocade, and reading the transcripts it seems clear to a layman that the prosecution needs to make Reyes a bad guy all by his lonesome for some reason – insisting that folks like his CFO knew nothing. So why then only a few days after the verdict does the SEC indict the same Mr. Byrd for knowing and participating in the very things the government contends he knew nothing about days earlier?

From the SEC Filing (Just the first 2 complaints, but you'll see my point):

   

Plaintiff Securities and Exchange Commission (the "Commission") alleges:

SUMMARY OF THE ACTION

1. From at least 2000 through 2004, Brocade Communications Systems, Inc. ("Brocade" or

"the Company"), a San Jose computer storage networking company, concealed millions of dollars in

expenses from investors and significantly overstated its income by falsifying records relating to

employee stock option grants. The fraudulent scheme was executed by former chief executive officer

Gregory L. Reyes ("Reyes"), who routinely backdated stock option grants to give Brocade employees

and recruits valuable "in-the-money" stock options without disclosing the practice or recognizing the

required compensation expense on the Company's financial statements. To carry out this scheme, for

certain highly sought after recruits, Reyes and others falsified paperwork related to the grants to make

it look as if the employees had been hired and employed by Brocade long before the time they

actually started with the Company, so that those employees could receive options that were backdated

to a date in the past when Brocade's stock price was significantly lower.

2. Michael J. Byrd ("Byrd") was hired by Reyes in May 1999 as chief financial officer

("CFO), just as the Company went public. As CFO, Byrd had responsibility for preparing and

reviewing Brocade's annual and quarterly financial statements, which described the Company's

accounting for stock options. In May 2001, Byrd was promoted to chief operating officer ("COO")

and president, positions he maintained until he left Brocade in 2003. On multiple occasions, Byrd

learned that Reyes was claiming to have granted options to newly-hired executives, whom Byrd

understood were not actually employed by Brocade on the purported grant date. This resulted in the

issuance of in-the-money options to the executives, which were not properly accounted for in

Brocade's financial statements or disclosed to its shareholders. Byrd was also alerted to other facts

suggesting that the CEO was manipulating options grants.

So either the prosecutor knew he was lying about Byrd in the Reyes trial (which appears to be born out in the transcript as others testified that he knew everything) and did it anyway, or Mr. Byrd is getting railroaded by the SEC. I have trouble believing it is that.

There are a bunch of other interesting things I'll point out soon – one of which is around how no one on Wall St. cares about option expensing and therefore how it made no difference in the value of the stock. Jason Gold, a fund manager at Pequot Capital owned $500 million dollars worth of the stock and testified as such. So if the options backdating expense reporting didn't affect the stock price, then individual stockholders weren't affected, so where is the securities fraud? Not that "joey was doing it too" is any excuse at all, but 130 or so other companies also not "properly" expensing stock options and a clarification memo from the SEC due to confusion around the rules does lead one to believe that if no individual nor investor was negatively impacted and confusion abounds, it seems hard to prove intent to defraud. But again, I'm no lawyer, or judge.

So, once again I'm arguing with myself – but here's the point: Even if Reyes is a guilty as sin, the government has to be held to the highest standard, and when the government lies I get irritated. If you are going to send a person to jail, that person has to be guilty beyond a reasonable doubt and the prosecution has to be above reproach. If the prosecution cheats, the whole system is screwed.

I think that this story isn't over.

  

What’s In a Number?

When is the last time that anyone relevant paid attention – let alone based a buying decision – on ridiculous market share claims? IBM says it stole 1.2% of HP's storage business in Bolivia. Emulex/Q-Logic has 52.4% of the hotly contested Fibre Channel HBA in a server that sits next to a poster of Christie Brinkley in her day (she still looks great, and she's 87) vs. (Insert vendor here: Emulex/Q-Logic). Cisco has garnered 56% of the director market on Tuesdays following a snow storm – Brocade is vehemently denying this, and counters with the fact that Cisco is counting food service Ketchup/Catsup bottles twice. I made up all those statistics, but don't be surprised if you see them in a press release soon.

Who cares about all this? What possible value is it to anyone with a real job to listen to this stuff? It seems to me that the only folks who care are vendor employees who for some reason or another, continue to be measured in some way based on numbers derived from processes that are so fundamentally flawed that the only metric that matters is "do I get my bonus?". A peer review is one thing, but this has gone too far to be useful.

The only way any of this would be meaningful is if it were accurate and true – and as far as I can see, most of it is neither. Vendors don't report any numbers anymore, and those who count things use "models" – i.e. wild ass guesses based on mood or sponsorship. No one sits and counts physical shipments. The only valid way to do any of this is if you had a statistically significant sample of buyers and users that you monitored over time. Until then, it's just sort of silly.

Vendors use the numbers in three ways: 1. if any number makes them look good, they announce it to the world as proof positive that they are the king of whatever it is. They don't care if they get credited with being responsible for someone winning a medal at a beer festival or for discovering a new planet, nor do they care if the source is really a three legged dog in Mumbai with a parlor trick or two. If it's positive, it's true. 2. They have a Bolivian country manager that somehow gets paid if their number is positive – regardless of whether the overall company results just tanked worse than Waterworld, or 3. They use the inaccuracies and flawed methodologies to completely pooh-pooh the results as absurdly one sided and entirely useless. Those are the ones who didn't fare as well in the hyper-scientific analysis.

The fact is anyone can come up with any number anyone else wants. That's why it's stupid. No IT guy worth a dime will actually make a buying decision because "according to ABC, EMC has 98.5% of the worldwide NAS market" or "Cisco now has 87.4% of the world under its switching control". Any investor or hedge fund manager who puts any weight into these numbers will eventually be fired, and forced to live the remainder of their lives on a sweet Caribbean island counting their money. Tracking Microsoft's revenue by product in conjunction with total server shipments might yield some interesting results. Listening to numbers showing how Star Office is killing the Seattle folks won't.

Now, if the results were all true and accurate – and not wordsmithed to an outrageous extreme, they might be useful. I still don't think anyone would make a real decision to part with their money because of it – but it would at least help folks decide who gets a chance to play. I haven't met every single large shop in the world personally, but I refuse to believe that a Brocade/McData shop is going to dump what they have for Cisco just because Cisco is gaining share, or they are going to toss out Netapp because someone told them that EMC owns the entire landscape of Bakery supply NAS devices. Folks will apply some basic common sense most of the time. For example, there are only 2 real combatants in the Cisco/Brocade (McData) fibre channel switch/director war in the fortune 1000. Is it really reasonable to think that anyone would eliminate the only real competition because of some goofy report? Of course not. They would look at both, as the numbers clearly do signify that both are worth looking at. They would weigh each proposal on its own merits – and if the decision was made to really consider removing the incumbent – they would then go through the pain vs. pleasure analysis. At the end of the day, the buyer makes a choice – but I will lose my faith in humanity if that choice was made solely based on some report that showed that Vendor A was more Dolphin Friendly than Vendor B. Of the 467 things that should be considered on a major IT purchase, market share data should come in at about 468.

QLogic and Emulex enjoy a relative duopoly. Cisco has made huge advances into the core of the largest data centers with their director products – but Brocade still owns the overwhelming percentage of switch ports. People are buying more Brocade/McData than they did last year, the year before that, and so on. The McData acquisition questions have been answered – the sky is not falling, and conversely, looks pretty bright. Wisely, Cisco tried to capitalize on the fear that any major merger drags, and who can blame them? Regardless of the fuzzy numbers, the fact is that Cisco is also selling more than they did last year, and so on. EMC knows that in a pure NAS play they don't sell as much as Network Appliance, but why would they correct the perception? EMC sells more everything storage related than anyone else, not to mention a few fairly successful non-storage things – so who cares? IBM, that's who. Real people? They don't care.

It would be helpful if someone started counted things that mattered – like what works and what doesn't, and how painful it was to Yankee fans to see that the Red Sox are now America's team – according to statistics published by USA Today, which unlike all those shoddy research outfits, clearly is an unbiased, above reproach example of how things should be done…..

Dirty Trick Alert

I've been asked by a few ESG clients if they should be participating/sponsoring something published by an outfit called the GDS Publishing, who owns Business Management Magazine (http://www.busmanagement.com/ ) – who are apparently publishing a book/directory or something that supposedly contains big important research and stuff from me, Jon Toigo, and Laura Dubois (IDC).

While true they did ask me to participate, I have declined – due to this type of practice – so while it may be worthwhile, I doubt it, and if it matters neither myself nor ESG have anything to do with it. I don't know if Jon and Laura are participating or not.

On one hand it's flattering to have my name used as someone's bait, but on the other hand it's annoying. Do proceed cautiously. They appear to be acting in bad faith – and trying to get $17,000 bucks or so from the vendors to be included and to add some on-line case study.

I don't blame them for trying, though you really ought to question the validity of anything where the primary marketing message is a complete lie.

Once when I was young and (more) naïve, I let this happen to me by a dirt bag expo vendor out of Chicago that I can't remember the name of. I had to sue them, which I did – and won – though still have never received a dime. They used my name to attract vendors to exhibit at some useless event where the only attendees were those same vendors. By all means let me know if you are approached by these folks. I haven't sued anyone in a while and my lawyers are probably bored.

----Update – it was Active Communications (www.acius.net) that was the dirty conference company. Looks like they will do a conference on anything anyone is talking about. Beware…..

VMware

VMware might be the best thing that’s happened to networked storage since, well, networked storage.

So you think EMC bought VMware because it was cheap? At $635 million, it didn’t seem cheap at the time; many folks wondered if EMC knew what it was doing or if it was just chucking more garf against the wall to see what stuck.

VMware is worth approximately $20 billion today (post IPO trading at $58 beans a share, up 100% from the offering price in 48 hours), so no one is questioning the decision any longer, but that still doesn’t explain its real value to storage. EMC is no longer the nemesis;  VMware has invigorated the industry.

When people consolidate servers by jamming virtual servers onto the same physical platform, they also move to a network storage architecture. VMware has figured out the recipe to get us to migrate from a DAS world to the networked storage world … and it had nothing to do with storage.

Many VMware installations are also big SAN and NAS shops (more importantly, many aren’t), yet the decision to move to SAN/NAS is never retroactive. Because data growth is never-ending, we found ourselves starting the process with some new app and then constantly adding to the SAN/NAS environment as we learned that it was a smarter way of interconnecting storage to servers vs. having the storage bound to a single physical machine. We’ve known networked storage has been a better way to go for many years, but until VMware got hot, we allowed a massive percentage of our overall data to reside in single-server configurations. Why? Because the server is still the psychological king of the data center.

A server is a processor and memory subsystem that costs approximately $1,000. It’s almost a throwaway when compared to today’s true big iron—storage. Servers are grossly underutilized and their volume causes tremendous operational problems and inefficiencies. The storage connected to the average server houses data whose value is incalculable. The time and money saved by creating networked storage environments, along with the ability to better protect and deliver our most precious corporate asset—our information—isn’t debated anymore. Why won’t we move the DAS to a NAS/SAN environment when it’s the obvious thing to do? Why does it take a server consolidation to make it happen? We’ve found the motivation and it’s VMware.

I think VMware is brilliant, but I also think it’s unoriginal. Storage guys figured out that individually underutilized disks spread all over the place and directly connected to individual machines was dumb approximately 20 years ago. We “consolidated” those drives into large-scale RAID arrays and NAS boxes. We networked those consolidated drives back to the machines that needed them. Isn’t VMware doing for servers what storage guys figured out long ago?

As folks move to virtual server environments, they’re forced to move to networked storage (or they can’t take advantage of any of the VMotion-type features and that would be dumb). This is the catalyst to mass-market adoption of network storage technologies—to extend their use in existing SAN/NAS places and add new opportunities. Because of the virtual server phenomenon, there may be more networked storage implementations within the next year than we’ve seen in the last 10 years.

So instead of doing the normal EMC bashing, you might want to say thanks. VMware has opened more doors for old and new players than any other movement I can think of over the last decade. And once a door opens, all sorts of things can come in.

Two final notes:  first, in a panic reaction to the death toll that VMware potentially represents for Citrix, Citrix bought Xen (another server virtualization player) for $500 million beans.  I think Xen has about the equivilant revenues as my 6 year old's lemonade stand.  (For the record, he is willing to entertain offers between $200-$400 million).  Virtual Iron is the only other would-be player left (other than Microsoft of course, but I don't think they are considered a buyout target at this point), but no one knows who they are.

Second, I wrote this for Storage Magazine about 3 months ago (I updated the numbers), and since have discovered something - maybe DAS isn't going to have to go away afterall.  If VMware plops a distributed file system into their offering, they could effectively give you networked storage without having to physically move any of the DAS devices.  Hmmmm.

Greg Reyes, And The Red Sox.....

Greg Reyes, former CEO of Brocade, was convicted of 10 counts of fraud involving backdating stock options.  The practice, in case you are unaware, is when executives knowingly issue stock options in arrears, when a stock price was lower, to create instant value and wealth.

The practice, unfortunately, was widespread and far reaching.  Reyes is appealing, and continues to tout his innocence.  The Justice Department clearly went after him with all it's weapons, as an example and poster child for how this corporate badness just won't be tolerated.

In everything I've read, Reyes didn't really profit personally from the act - he was already loaded.

So, this chapter continues, but it does hopefully show the next generation that they will either have to resign themselves to doing things the right way, or find new ways to cheat.  I like Greg personally.  He is a tall, rich, charismatic person who embodied the "go go days" of the storage market.  He came from money, made his own on top, and now is facing 20 years in jail. 

Which gets me to the Red Sox.   You skate through some times, when everything is smooth sailing and you can do no wrong.  Brocade and Greg did that thru the gold rush.  The Sox were up 12.5 games a month ago - and goofy fans said "it's all over!"  Party on.  The problem is, if it's too good to last - it won't.  Now the stinkin Yankees are 5 games out, and I'm losing sleep. 

You can't skate in this world - you gotta put in the effort even when you are winning.  How many companies lost the magic they had because they got cocky or arrogant and figured it would never end?  We act like it becomes our "right" to succeed.

Here's 43 years of chemically depleted knowledge for you:   Don't cheat.  Don't lie.  Never, ever think that anyone owes you your rightful place in life - you gotta earn it every day.  The worst is when you truly believe that you know better, or are above the law, or that since you are smarter and better looking, that little things like rules and morals don't apply to you.  Those are the people to stay away from. Those are the companies to run from.

The Sox better start playing the game the old fashioned way again, and get their heads out of the clouds, because I can't take another riches to rags NY ending.

Acopia Sells to F5

For 210 Million reasons. It's a bit melancholy for me, however. I understand the deal – F5 wants to be the guy in the mega-core to take on Cisco in large distributed networks, and the only way to do that is to be relevant – and the only way to be really relevant is to be part of the value chain, not just delivery chain. Acopia, in theory, enables big shops to centralize, coordinate, and deliver file services on a global basis – over IP networks.

What's a drag is A: I thought that Acopia really had a shot to get a huge deal done – either thru a public offering or a bigger exit (in another year) and B: these were the last guys standing in the high-end network intelligence game. Neopath got sold for a can of coke, and then promptly killed off. Rainfinity went out pretty big, but early, to EMC. Brocade bought Storage X for relatively small dollars. Now where is the excitement going to come from?

It's not like file virtualization and delivery services aren't needed – they absolutely are. Riverbed doesn't virtualize, but delivers, and is riding a huge multiple because of what they deliver – mostly files. The world has moved on – it's all about the file, so the problems associated with the file aren't going to get easier to deal with, only harder. The value of the file isn't going to diminish, but increase. Therefore, the folks who can make it easier to apply intelligence, management, and security to the file should have a natural spot in the value chain.

No one is offering me $210 clams for my two cents, so I can't say they should have held out. It's a lot of money, and lets face it, a positive portfolio exit means a lot to VC's who are sucking wind with their last 5 years of investments. I don't blame anybody for cashing out.

It will be interesting to see how F5 plays it – do they move into the space in earnest or do they just use it as window dressing? They continue to face a tough battle in their own worlds, so seeing how they divest into new adjacent opportunities will be telling. The fact is, they can get into more conversations with more big shops now than they could before – the question is will they?

Congrats to the folks in Lowell – which sounds like an oxymoron, I know.

The Machine Has No Soul - Or Backup Singers

The reason the human will always be required at some relevant level in the implementation and use of computing technologies is pretty simple - the computer can execute a codified series of events much faster and more consistent than any human, but it can't write a song.

The ability to create - not "think" - is what separates us from the Duo-Core next door.  The issue is our society values the Duo more than the Doo-Wop.

I went to see one of my favorite bands, Steely Dan, recently.  They are one of the more talented batch of folks you might ever see - from a few (2) guys ability to even conceive of a song to begin with, to being able to layer on many other elements musically which individually might be interesting - but holistically form pure brilliance.  I can't see a machine ever writing a song.

So Steely Dan, with it's primary driving creative genius at the helm, had about 10 backing musicians.  Each was absolutely amazing in their craft.  Each may have been among the top 10  on the planet capable of performing at that level.  Each probably made about $50,000 a year.  Each could have been replaced by a machine at any moment.

It sucks, but that's kind of like IT (except rarely in IT do I see smoking hot backup singers).  The systems we build are superb at executing the tasks we tell them to execute - but those tasks require the creative genius of the strategic human who can "see and hear" what the symphony should be - and we don't value those strategic maestro's of IT in our society - so we end up with well meaning supporting musicians trying to keep up with the whims of guy who owns the place instead of being encouraged to express the creativity we posses.  And then we try to automate or outsource those guys too.

IT guys range from the best contract musician in the band to pure road crew.  It is very rare that a true IT maestro is allowed to practice their craft - not without lots of "patrons of the arts" being willing to dole out lots of dough simply because they believe it is important.  While history is littered with examples of world changing genius, from Mozart to Joe Strummer, why is it there are only a handful of IT types who have been allowed to perform?  Beethoven didn't need to develop the piano - he simply mastered its use.  The CIO doesn't have to develop the next core - they need to conceive and create a better way to harmoniously use the instruments at their disposal to create magic. The Web 2.0 movement, with all it's ramifications, screams for creative new leadership in IT.  It is sort of like we are leaving the Disco and Techno era's - people can't take stupid much longer.

It has happened.  How many Google's, Amazon's, MySpace's, etc. do you need to see change the world to see that they were not simply lucky?  IT IS the business in the new world order - but you ain't gonna be anything but a hack lounge band if you don't hire a maestro to see it - and then encourage and support them.  Maybe an acid trip will loosen you up to the possibilities.

Side Note:  You know you are old when the shows you enjoy are the same that you enjoyed 20 years ago - with reverse metrics.  20 Years ago at a Steely Dan show there was much more hair than money, but today it's the exact opposite.  It was a sea of 40 something bald men in Gucci shoes.  At least there were smoking hot backup singers.