Corporate Action Election

A corporate action election is the decision a holder of securities makes when a corporate event offers more than one outcome, together with the act of communicating that decision. Examples are choosing whether to accept a tender offer, whether to take up a rights issue, or whether to receive a dividend in cash or in shares. The holder tells its custodian or broker what it wants, and the instruction is passed up the chain of intermediaries to the issuer or its agent.

Elections arise only in events that give holders a choice. A voluntary corporate action takes effect only for holders who choose to participate. A mandatory with options corporate action will happen in any case, but holders can select the form of what they receive. A purely mandatory event involves no election.

Common cases include:

• Tender offers and buybacks. Holders choose whether to sell some or all of their securities at the offered price; see tender offer processing.
• Rights issues. Holders choose to subscribe for new shares, sell their rights or let them lapse; see rights exercise.
• Optional dividends. Holders choose between cash and new shares, as with a scrip dividend, or between currencies.
• Mergers with a mix of consideration. Holders choose cash, shares or a combination, subject to limits.
• Exchange offers, conversions and puts. Holders of bonds or convertible securities choose whether to exchange, convert or demand repayment.

Voting at shareholder meetings follows a similar chain but is treated as a separate process.

The process starts when the custodian sends the holder a corporate action notification. This describes the event, numbers each option, states which is the default, and gives the deadline for replying. The holder, or the investment manager acting for it, decides and sends an election instruction, a type of asset servicing instruction that identifies the account, the security, the event, the option chosen and the quantity. A holder may split a position across options.

The custodian bank validates the instruction against the holding, and usually blocks or segregates the securities concerned so that they cannot be sold or lent. It then combines its clients' instructions and passes them to the next intermediary or to the depository, which forwards totals to the issuer's agent. After the market deadline, the agent calculates the outcome, applying any scaling back if an option is oversubscribed. Proceeds are paid down the chain on the payment date, and each intermediary allocates them to clients according to their elections.

There is not one deadline but a series. The issuer sets a market deadline by which its agent must receive instructions. Each intermediary below sets an earlier election deadline for its own clients, to allow time for checking and onward transmission. A holder at the end of a long custody chain may therefore have to decide days before the market deadline, and well before the latest information about the event is available.

Trades executed shortly before the deadline complicate matters. A buyer whose purchase has not yet settled cannot instruct on securities it does not hold. Market practice addresses this through buyer protection: provided the trade was executed by the guaranteed participation date, the buyer can require the seller, who still holds the securities, to elect as the buyer directs.

Instructions can often be withdrawn or changed until the deadline, though some offers make acceptance irrevocable.

If no instruction is received, the default option applies. The issuer specifies it in the terms of the event; for a tender offer it is to take no action, and for a dividend with a share alternative it is usually cash.

The default is not always the most valuable choice. Letting rights lapse, for example, can mean losing their market value altogether unless the issuer arranges for lapsed rights to be sold for holders' benefit. Custodians therefore chase clients who have not responded as a deadline approaches, and investment managers treat an unintended default as an error.

The main failures are missed deadlines, instructions for the wrong option or quantity, instructions on securities that have since been sold or are out on loan, and errors in combining client instructions within an omnibus account. A mistake usually results in a direct financial loss, since the economic difference between options can be large and cannot be reversed once the event has closed. The intermediary at fault is expected to compensate the client.

Controls include deadline diaries with escalating reminders, independent review of manually entered instructions, reconciliation of instructed quantities against settled positions at each level, recall of lent securities ahead of elective events, and confirmation of every instruction and of the final outcome. Entitlements are then checked through corporate action entitlement calculation.