The (Option) Dating Game

On February 4, 2014, the CBC reported that Ensign Energy Services has been accused of option backdating. The lawsuit was filed by Siskinds LLP on behalf of an Ensign shareholder. I have written a fair amount of backdating in Canada including here, here, here, and here and I’ll summarize the issues here in this blog.

Stock option backdating, in its most basic form, is the use of hindsight to selectively pick a local low point in a stock’s trading price and issue executive stock options stipulating the selected date as the grant date when, in fact, the options are granted at a later date.  Because the backdated options’ strike price is lower than the market price on the actual grant date, the recipient has received something of greater monetary value than a correctly dated at-the-money option.

The figure below is an example. Day 0 represents the reported date of an option award. As you can see, this day represents the lowest point that the stock traded at within a look back window. Yes, it is possible to randomly hit such a pattern, but backdating is about companies repeatedly having such good luck with their option awards. In reality, the stock option was granted sometime after day 0 and backdated to day 0.

Capture

Why should we care about backdating? First, backdating is not a legal activity in Canada. In addition to securities law requirements, all companies listed on the TSC must comply with the TSX Company Manual which prohibits backdating.

Second, backdating has predominantly been confined to executive stock options, a cadre of people who already earn obscene amounts of compensation and don’t need to engage in such nefarious behaviour to further increase their remuneration.

Third, further complicating matters is that backdating results is a form of tax non-compliance. This is because stock options that are not-in-the-money are given preferential tax treatment to those granted in-the-money. Because backdating options are really in-the-money options made to look like not-in-the-money options, the recipient is able to take advantage of a generous tax treatment that they are not rightfully eligible for.

There are simple ways to reduce or eliminate stock option backdating. The simplest method of all is to require that the company publicly announce through a press release any and all stock option awards on the day they are awarded. This is already in place for companies listed on the TSX-Venture exchange. Provided there were also in place sufficiently severe consequences in the event of a failure to comply it would effectively eliminate the ability to backdate.

We also need more research into backdating in Canada. What is frustrating for me working in this area is that I know there is sufficient evidence of the practice, but getting published has been difficult because most journals don’t want to publish papers based on Canadian data.

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