Hank Swartout has left his company. Well, not exactly, but it's easy to understand the confusion. At Precision Drilling Trust, you can collect a handsome severance -- and a retirement allowance -- without having to clear out your desk.
Mr. Swartout received $2.9-million for retiring, even though he will remain the company's chairman and chief executive officer for most of this year, according to a company circular issued last week. He also pocketed $12.6-million in special severance-like payments (and was allowed to buy his $74,000 company-bought vehicle for a loonie) because of his company's conversion to an income trust last fall.
Never mind that Precision's managers didn't change, and that no round of pink slips was issued. Never mind that the shareholder roster is pretty much unchanged, or that the corporate offices didn't move. Precision determined that its transformation into a trust was a change of control, and that was enough to unshackle tens of millions of dollars in stock options for senior management, and to trigger the lucrative payments to Mr. Swartout.
For the Ontario Teachers Pension Plan Board, which opposed the Precision trust conversion even before it knew the full details of Mr. Swartout's windfall, it is the "most egregious" example of what it deems to be a disturbing escalation of excessive compensation practices in the oil patch.
Critics charge that good governance is being sacrificed in the mad rush to cash in on the energy boom, much as it was during the dot-com craze, and that executives are taking more than their fair share of the gravy. Change-of-control contracts are triggering millions of dollars' worth of payments to top brass, even in instances where there is no change of control and nobody loses their jobs. There are also growing concerns that simple trust conversions or mergers are providing insiders with an easy way to cash out their stock options and get their hands on cheap shares in spinoff exploration companies.
"Management is basically going home on Friday and coming in to work on Monday in the same job with the same responsibilities," said Brian Gibson, a Teachers senior vice-president. "I can't imagine how any self-respecting director would agree to an arrangement like that . . . In Calgary, in particular, it seems like it's just a standard thing to do. When there's a corporate development of any kind, management just put a lot of money in their pockets in the process, regardless of whether they created value or not."
The Precision chairman did not comment, and the company said the directors who sit on its compensation committee declined an interview. However, the payments that Precision made are no aberration in the oil patch. (If the Precision deal is unusual at all, it is only because Mr. Swartout was the sole recipient of change-of-control payments. Other senior managers had no such luck, since, unlike Mr. Swartout's, their contracts specified that they had to lose their jobs before receiving any such payout. Mr. Swartout relinquished the title of president, but that was not the trigger for his payments.)
Plenty of other examples abound. When Harvest Energy Trust and Viking Energy Royalty Trust unveiled their planned nuptials in January, top executives at both companies were paid millions of dollars in change-of-control payments, even though almost all of them kept their jobs. Their stock options also vested immediately as part of the deal, meaning they could cash them out whenever they liked.
John Zahary, the former Viking CEO who now heads up the combined company, under the Harvest name, defended the decision to pay Harvest insiders a total of $3.1-million, even though they were remaining in the executive suite. The problem, he said, was that the deal triggered a change-of-control clause at Viking, requiring the smaller company to pay a total of $1.4-million to its top brass. The boards decided that since the Viking people were getting some money, the Harvest people should too.
"You're blending two sides together, and it seems the equitable thing to do: to treat both sides equally," said Mr. Zahary, adding that some of these executives took on different roles after the mergers.
He acknowledged that some people may have an issue with the acceleration of stock option schedules, but he doesn't see how that gives management much of an edge. "Having those [options]vest now, and be free to exercise them today, may be perceived as an advantage. But the market isn't expecting commodity prices to go down."
Nobody has suggested that this was a bad deal. Quite the opposite, in fact. It was strongly endorsed by shareholders, and has done well in the markets. But even those who defend the principle of such arrangements are beginning to have qualms about change-of-control payouts. The intent of these provisions is to ensure that executives remain independent when they evaluate a potential business deal, rather than fret about losing their individual salaries. But payouts that are too rich could have the opposite effect, and encourage CEOs to wade into deals for self-enrichment.
"There is a sense here that things are a bit excessive," said a mergers and acquisitions lawyer in Calgary. "You effectively have incentives for people to do bad deals."
John Brussa, a Calgary lawyer who is a director of Harvest and part of its compensation committee, said he understands the philosophical objections -- but insists that such protests ignore the reality of the oil patch, where there is a heated bidding war for the skills of a small pool of petroleum engineers. "I'm not sure you can use an off-the-rack solution in a tailor-made world."
Change-of-control payouts have become more common recently.
StarPoint Energy Trust and its head Paul Colborne are a case in point. Last fall, StarPoint merged with Acclaim Energy Trust to form Canetic Resources Trust, a company headed by the Acclaim management. The merged entity spun out a small exploration-oriented junior, TriStar Oil and Gas Ltd., led by StarPoint's management team.
The Acclaim executives voluntarily gave up their cash payments, even though there was technically a change of control. But Mr. Colborne's group received nearly $4-million. What's more, Mr. Colborne received money from a change of control, even though he did not have an employment contract that stipulated such payments. (The information circular for the Acclaim-StarPoint merger says the rights granted to other executives were extended to Mr. Colborne as part of the deal.) He declined to comment.
Bill Mackenzie, president of investor activist firm ISS, said "single trigger" change-of-control payments, which allow employees to cash in without leaving their jobs, should simply be banned.
"It should be a double trigger -- you should lose your job, too. Nobody [among investors]seems to fight it when they're making money. It's like the options during the tech boom. It sounds like we need a better crop of directors out west."
Change-of-control payments are just one of the problems cited by disgruntled governance activists. Another compensation vehicle that has proliferated in the patch, and caused consternation in some investor circles, is the practice of offering executives cheap shares in junior exploration companies that are spun into the markets following a trust merger.
The Toronto Stock Exchange served notice a few months ago that it was scrutinizing these private placement deals, which work like this: Two trusts will merge, and then spin out a junior exploration company, often providing management with cheap shares in the smaller company before it begins trading.
Mr. Colborne's former company, StarPoint, was criticized after it merged with APF Energy Trust last spring, and spun off a junior called Rockyview in a deal Teachers warned could be "lucrative to insiders and expensive for shareholders." In a similar transaction, Fairborne Energy Ltd. hived off a smaller exploration concern called Fairquest Energy Ltd., and allowed its insiders to buy into a private placement for $2.11 a share. The stock rocketed on its first day of trading, and now trades above $6: tripling the paper profit of insiders.
In many of these deals, the companies also accelerate the vesting of stock options for management, allowing them to cash out their stakes immediately. Take Penn West Petroleum Ltd. and Precision Drilling, a pair of controversial income trust conversions.
The Ontario Municipal Employees Retirement Board (OMERS), Canada's fourth-biggest pension fund, voted against Precision's decision to become a trust, saying "the plans make way for egregious payouts to insiders." In addition to the rich payments to Mr. Swartout described above, OMERS noted that Precision insiders, primarily management and directors, held 5.5 million options worth potentially $165-million at the time.
Teachers, meanwhile, led the revolt against Penn West, claiming that executives shouldn't be allowed to exercise their options early for what amounts to little more than a change in the firm's legal structure.
"What's happened is it's just become a way for management to get extra money when nothing is actually changing in their lives," said Mr. Gibson of Teachers. "Management argues that trust conversions are making the company more valuable [but]that's management's job in the first place -- to create value."
Criticism from eastern financiers tends not to play well in Calgary, and usually elicits the retort that outsiders don't understand the oil patch's close-knit business culture, or its need to pay for specialized talent. But some, including the Calgary M&A specialist, reject that argument, saying the market isn't entitled to claim a distinct status. "What Calgary should be doing is adhering to good governance standards, and not just being the Wild West."
OIL PATCH'S BIG PAYDAY
Discounted placements to insiders have been a source of controversy in the oil patch. The placements typically work as follows: A company (or mergered companies) converts to a trust, and then spins off a junior exploration company. Before it goes public, the smaller company issues cheap stock to insiders. The following chart, compiled by Institutional Investor Services, shows how lucrative the practice can be.
|OFFER PRICE PER UNIT TO INSIDERS||INITIAL MARKET VALUE PER UNIT*||VALUE OF PAPER GAIN FOR INSIDERS FIRST DAY|
|Tristar Oil & Gas Ltd||$2.75||$8.8||$16.5-million|
|Vero Energy Inc||$2.22||$5.05||$6.4-million|
|Zenas Energy Corp||$1.50||$5.07||$14.3-million|
|Valiant Energy Inc||$2.52||$4.30||$2.8-million|
|Fairquest Energy Ltd||$2.11||$11.72||$45.6-million|
|White Fire Energy Ltd||$1.29||$4.55||$15.1-million|
|Kereco Energy Ltd||$2.60||$14.33||$27.1-million|
|Bear Ridge Resources||$1.175||$5.62||$15.1-million|
*Figures includes both the value of the stock at close of trading on the first day, along with the value of any warrants attached to the units.
CHART SOURCE: INSTITUTIONAL SHAREHOLDER SERVICES
CASE STUDY: HOW CHANGE-OF-CONTROL PAYMENTS WORK
The pace of acquisitions, mergers and spinoffs in oil and gas is accelerating as consolidation sweeps through the trust sector. At the same time, change-of-control compensation is becoming more common. The flurry of deals by oil patch entrepreneur Paul Colborne is a case in point
TODD KOROL/THE GLOBE AND MAIL
TODD KOROL/THE GLOBE AND MAIL
Paul Colborne was among StarPoint Energy Trust executives who received $3.96-million in change-of-control payments when it merged with Acclaim Energy Trust last December.
Crescent Point Energy Ltd. merges with Tappit Resources Ltd.
Trust offspring: Crescent Point Energy Trust
Junior offspring: StarPoint Energy Ltd.
Change-of-control payments: None for Crescent Point management, including CEO Paul Colborne; up to $591,000 for Tappit
Existing options: Immediate vesting. Crescent Point, worth $4.5-million; Tappit, all 1.6 million options
New incentive plan: StarPoint employees and directors receive a total of 2.5 million options and a private placement of up to $6-million
StarPoint Energy Ltd. merges with E3 Energy Inc.
Trust offspring: StarPoint Energy
Junior offspring: Mission Oil and Gas
Change-of-control payments: None for Paul Colborne or other StarPoint management; up to $1.45-million for E3 management
Existing options: All options vest; transaction assumes E3 management exercises options; unexercised options exchanged for equivalent in StarPoint trust and Mission Oil
New incentive plan: Restricted units for StarPoint management, up to 5 per cent of outstanding units and exchangeable shares.
StarPoint Energy Trust acquires APF
Trust offspring: StarPoint Energy Trust
Junior offspring: Rockyview Energy Inc.
Change-of-control payments: None for StarPoint; up to $6.3-million in severance and other payments for APF
Existing options: No details on vesting, but all unexercised APF options to be cancelled.
New incentive plan: No details provided.
StarPoint Energy Trust merges with Acclaim Energy Trust
Trust offspring: Canetic Resources Trust
Junior offspring: TriStar Oil & Gas Ltd.
Change-of-control payments: Acclaim executives waive payments; StarPoint executives receive $3.96-million, including Paul Colborne, who is included despite his employment agreement not providing for a change-of-control payment.
Existing options: Incentive units held by StarPoint and Acclaim management vest, although Acclaim executives place one-third of those holdings in voluntary escrow.
New incentive plan: Options up to 10 per cent of share base for TriStar, plus private placement of up to 2.7 million common shares at issue price of $2.75 a share and 2.3 million TriStar performance shares, convertible into common shares; for Canetic, restricted awards and performance awards, both vesting in part after three years and the latter tied to trust unit returns.