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Canadian firms expected to escape stock scandals

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Canadian companies have largely been insulated from the stock options scandal that has affected more than 100 U.S. companies because of Canada's securities laws and tax rules that impede backdating of options, lawyers and insurance market sources say.

While insurers are asking Canadian policyholders about option granting practices, options backdating is not expected to be a major issue from a directors and officers liability insurance perspective. Questions, though, have arisen about whether these laws and rules are sufficient to prevent backdating in Canada.

Only one Canadian company--Research in Motion Ltd., the maker of the Blackberry wireless communications device--appears to be caught up in U.S. investigations of retroactively dating stock option grants to boost profits for the recipients. The Waterloo, Ontario-based company said its audit committee was voluntarily reviewing its option granting practices and that it had received a letter of informal inquiry from the U.S. Securities and Exchange Commission related to its stock option grants and practices.

In response to inquiries from Canadian market participants spurred by news of the U.S. probes, the Canadian Securities Administrators--the council of securities regulators of Canada's provinces and territories--has published a notice of Canadian regulatory and legislative requirements that the organization said may reduce the opportunity for Canadian companies to backdate option grants.

For example, the Toronto Stock Exchange, where the majority of publicly listed Canadian companies are traded, requires that the exercise price for options granted by listed companies not be less than the market price of the underlying securities when the options are granted, and that the exercise price be based only on publicly disclosed information.

While a company could ignore the TSX rules, it would be highly visible to securities regulators and make it "harder for people to manipulate the system, even if they wanted to," said John Tuzyk, a partner in the business/securities group at law firm Blake, Cassels & Graydon L.L.P. in Toronto.

Also, Canadian securities law generally requires company insiders to file an electronic report within 10 days of any change in their direct or indirect beneficial ownership, control or direction of company securities, including options.

These requirements are reinforced by Canadian tax rules that provide favorable tax treatment for employee stock options, provided the exercise price is not less than the fair market value on the grant date, said Andrew MacDougall, a partner in the business law department at law firm Osler, Hoskin & Harcourt L.L.P. in Toronto.

Rules have no bite: Study

Recently published research by three University of Manitoba professors, though, questions if the securities rules are sufficient to prevent stock option backdating, pointing to enforcement gaps and the lack of stiff penalties for violations. Despite the 10-day reporting requirement, the professors found almost 17% of all insider option grant reports are filed late. "What the CSA seems to be missing is that these rules do not necessarily have bite in terms of reducing backdating," the study said. "Certainly, they serve to make backdating an illegal activity, but still the opportunity to backdate remains if companies are willing to break the rules."

The backdating scandal's key impact is a heightened insurer focus in questioning the option granting practices of Canadian policyholders as well as executive compensation practice, brokers say.

Insurers "dislike the risks where it's been a poor year for the company and record results for the executives," said Jonathan Ashall, senior vp, regional director for the executive risk practice of Willis Canada in Toronto.

Plaintiff attorneys are starting to examine compensation committees and boards for approving "egregious" executive salaries, said Scott Saddington, chief underwriting officer for Toronto-based Executive Risk Services Ltd.

Canadian law does protect directors making compensation decisions in good faith, lawyers say.

The introduction of new corporate disclosure requirements in Alberta, Manitoba and Ontario, though, create a potential liability for Canadian companies and their directors and officers, who could be sued in relation to a material omission or materially incorrect statements in earnings reports, among other items related to executive compensation, Mr. MacDougall said (BI, Jan. 8).