Originally published in Blakes Bulletin on
Litigation/Securities Regulation, November 2009
Recently, there has been a spate of letters forwarded to
corporations, by plaintiffs' counsel, impugning the stock
option practices of various corporations. As described below, the
settlement involving Savanna Energy Services Corp. (Savanna)
relating to such allegations has resulted in what was described by
plaintiffs' counsel as the first such application to be brought
in Alberta, and only the second in Canada (following the Research
In Motion settlement in Ontario). Based upon the settlements
involving both of those corporations, and the sizable monetary
reward potential accruing to plaintiffs' counsel, it can be
expected that those settlements are a harbinger of things to
Typically, plaintiffs' counsel undertakes a review of
publicly available information to investigate stock options granted
by the corporation. That investigation is often followed by a
demand letter wherein it is alleged that, based upon the
examination of that information, it appears that the dates upon
which the corporation granted stock options to its directors and
officers have been manipulated. The most common allegation is that
stock options that were reported to have been granted at-the-money
were, in fact, implicitly granted in-the-money. It is also often
alleged that the corporation granted stock options to insiders
which were manipulated in some other manner, whether through
backdating, spring-loading or otherwise. The demand letter then
requests that the company undertake an independent investigation of
the corporation's stock option practices. To the extent the
corporation refuses to undertake such an independent investigation,
that has resulted in a representative shareholder seeking, by
Originating Notice, an order that the court grant leave to the
shareholder to bring a derivative action in the name of the
corporation. In addition, the Originating Notices reviewed have
requested that the court grant various orders prohibiting the
corporation from granting further options and to prohibit directors
or officers from exercising outstanding options. In addition, the
plaintiff may seek an order requiring the corporation to produce
all relevant documents and records and authorizing the applicant to
retain legal and accounting assistance and other related
Such relief was sought in March 2009 against Savanna and certain
of its officers and directors. The Originating Notice of the
applicant was supported by the affidavit of a university professor,
which contained an analysis and an opinion regarding stock price
data and other public information filed by Savanna including its
Annual Information Forms, Proxy Circulars, SEDAR Reports and other
public information. The upshot of that evidence was that there was
an alleged high statistical probability of Savanna breaching
applicable TSX regulations.
Subsequent to the filing of the Originating Notice, Savanna and
the individual respondents agreed to undertake an independent
investigation which ultimately resulted in a settlement which
included payment of counsel fees of 2.5 times the fees actually
incurred (to reflect the contingency agreement which amounted to
approximately C$600,000) plus disbursements and GST, payment by two
officers of the investigation costs (which also totalled
approximately C$600,000), the adoption by Savanna of a series of
corporate governance enhancements and the re-pricing of a number of
stock options alleged by the plaintiff to have resulted in
reversing about C$2- million in previously exercised options.
It has been reported that plaintiffs' counsel employ
researchers and experts who are dedicated to undertaking a review
of publicly available information on similar matters. Such
investigations and the sending of similar demand letters can
provide a "free option" to plaintiffs because the
corporation may undertake an investigation which could potentially
result in some type of settlement being reached.
If a company receives such a demand letter, it should obviously
retain legal counsel to provide advice and guidance which would
typically include formulating a protocol which, among other things,
protects privilege in connection with any investigation, and
preserves evidence to assist in defending such allegations.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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