CHARGES FILED AGAINST FORMER
EXECUTIVES OF ENTERASYS NETWORK SYSTEMS, INC.

WASHINGTON, D.C. - Assistant Attorney General Christopher A. Wray of the Criminal Division and Acting United States Attorney Peter E. Papps for the District of New Hampshire today announced the filing of an indictment against three former executives of Enterasys Network Systems, Inc., a computer hardware and software corporation previously headquartered in Rochester, New Hampshire, on fraud and related charges. In addition, a fourth executive pleaded guilty to related charges on May 17, 2004.

The charges against the indicted defendants stem from an alleged revenue recognition scheme that involved altering and backdating contracts, entering into secret side deals and making false representations in filings to the U.S. Securities and Exchange Commission (SEC), in company press releases and to the company’s outside auditors.

Enterasys succeeded Cabletron Systems, Inc., when the two companies merged in August 2001. Enterasys stock is publicly traded as ETS on the New York Stock Exchange. Enterasys is now headquartered in Andover, Massachusetts.

The 15-count indictment charges the three former executives with conspiracy, securities fraud, wire fraud and mail fraud. The indictment names: New Hampshire resident Robert J. Gagalis, 49, former executive vice president and chief financial officer; Maine resident Bruce D. Kay, 52, former senior vice president of finance; and New Hampshire resident Gayle Spence, a/k/a Gayle S. Luacaw, 45, former vice president and director of internal sales.

“The public is entitled to honest books that reflect the real value of a company,” said Assistant Attorney General Wray. “When corporate executives allegedly cook the books to create the illusion of success, they undermine the integrity of the marketplace.”

The indictment alleges that Gagalis, Kay, Spence and others caused Enterasys to falsely report that it had met or exceeded internal revenue projections and Wall Street expectations in order to maintain and increase the company’s stock price, as well as to enhance their own status and positions within the company. Specifically, at the close of the quarter ending on Sept. 1, 2001, the company’s outside auditors allegedly selected a number of transactions for revenue testing, including a transaction with a China-based company known as Ariel. As alleged in the indictment, the defendants and others became aware that the transaction documents contained terms that would negate recognizing approximately $3.5 million in revenue. Fully aware of the company’s efforts to “make its numbers” for the sixth consecutive quarter, the defendants and others allegedly caused one of the transaction documents to be altered by deleting the problematic terms and then backdating the document to make it appear that it had been executed before the close of the quarter. The defendants and others allegedly caused the altered and backdated document to be sent to the company’s outside auditors. In addition, the defendants and others allegedly issued a secret side letter to Ariel, which they withheld from the auditors, that restated the problematic terms. As alleged in the indictment, after altering and backdating the documents, the defendants caused Enterasys to issue a press release and to make an SEC filing which included the fraudulent revenue.

The indictment also charges Spence in connection with an additional transaction between Enterasys and a computer hardware and software developer known as SAP. According to the indictment, SAP sought an 18-month right to exchange $1 million in computer products it was purchasing from Enterasys in the final days of the quarter ending Dec. 29, 2001. The indictment alleges that Spence and another senior Enterasys official agreed to the right of exchange but insisted that SAP not refer to the right of exchange in its purchase order, as it would negate revenue recognition. The indictment further alleges that Spence and the Enterasys official promised to include the 18-month right of exchange in a secret side letter, which Spence then drafted and sent to SAP. After the fraud was uncovered, the company restated its earnings and reversed all of the revenue associated with the Ariel and SAP transactions.

If convicted, the defendants face a maximum sentence on the conspiracy charge (18 U.S.C. § 371) of five years in prison. The maximum sentence for securities fraud (15 U.S.C. §§ 78j(b), 78m(b)(2)(A), 78m(b)(5), 78ff; 17 C.F.R. §§ 240.10b-5, 240.13b2-1 and 240.13b2-2) is 10 years in prison. Wire fraud (18 U.S.C. § 1343) and mail fraud (18 U.S.C. § 1341) each carry a maximum sentence of five years in prison per count.

In addition, on May 17, 2004, Gary Workman, 57, a California resident and former president of Enterasys’ APAC Division, pleaded guilty to a one-count criminal information charging him with wire fraud for his participation in the fraudulent transaction with Ariel. Workman also entered into a cooperation agreement with the government.

The investigation is being conducted by the Federal Bureau of Investigation and the U.S. Postal Inspection Service. The case is being prosecuted by Fraud Section Trial Attorney Michael Koenig and Senior Counsel for Securities Fraud Thomas Hanusik of the Justice Department’s Criminal Division, and Assistant United States Attorney William Morse of the United States Attorney’s Office for the District of New Hampshire.

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