Mandatory with Options Corporate Action

A mandatory with options corporate action is an event that will take effect for every holder of a security, but in which holders may choose between two or more outcomes. The typical case is a dividend that may be taken in cash or in new shares. If a holder does nothing, the event still happens, and the holder receives whichever outcome the issuer has designated as the default. It is sometimes called a mandatory event with choice.

The category sits between a mandatory corporate action, where holders have no decision to make, and a voluntary corporate action, where nothing happens unless the holder elects to take part. For custodians, brokers and asset managers it is processed like a voluntary event, because instructions must be collected and passed on by a deadline, with the added feature that uninstructed positions cannot simply be ignored.

• Dividend with a share alternative. The company declares a dividend and offers new shares in place of cash, as in a scrip dividend. The default is usually cash.
• Dividend reinvestment. Holders may have their cash dividend used to buy shares in the market under a dividend reinvestment plan.
• Currency options. A dividend declared in one currency may be taken in one of several currencies.
• Mergers with mixed consideration. In a cash and stock merger, shareholders of the target may elect cash, shares of the acquirer or a mixture, often subject to overall limits that lead to elections being scaled back.
• Bond events. Interest that may be received in cash or in further bonds, and certain conversions and exchanges that are compulsory but offer alternative securities.

Every event of this type specifies a default option, which applies to any holding for which no valid election reaches the issuer's agent in time. The default protects the issuer and the market from unresolved positions. For the holder it means that inaction has consequences: the default may be less favourable than the alternative, for example where shares are offered at a discount to the market price, or where one option carries a different tax treatment.

There are in fact several layers of default. The issuer sets one. A custodian may apply its own default for clients who do not respond, which need not be the same, and an asset manager or wealth manager may have a standing instruction for each account, such as always taking cash. Disputes arise when a client assumes one default and the intermediary applies another, so the default is stated in each notification.

The sequence resembles that for other events, with an election stage added.

• Notification. After the announcement, entitled holders receive a corporate action notification listing the options, the default, the terms of each option and the deadlines. In ISO 15022 messaging the event carries an indicator showing that it is mandatory with a choice.
• Election. Holders choose through a corporate action election, and may split a holding between options where the terms allow. The intermediary records the choice and sends an election instruction up the custody chain.
• Deadlines. The issuer's agent sets a market deadline. Each intermediary sets an earlier election deadline for its own clients, so that instructions can be consolidated and forwarded; the investor's effective deadline may be several days before the market's.
• Entitlement and payment. After the deadline, the entitlement calculation is run separately for the positions electing each option and for uninstructed positions, and proceeds are distributed on the payment date.
• Reconciliation. Elections sent are agreed to elections acknowledged, and proceeds received are agreed to the breakdown expected.

Where the price of the share alternative or the exchange rate for a currency option is fixed only after the election period begins, a second notification gives the final terms.

Events with options are among the main sources of loss in asset servicing. A missed deadline cannot usually be repaired, since the agent will apply the default. Other failures include instructions that exceed the position held, elections made on positions that are out on loan or pledged as collateral and therefore not available, and errors in consolidating many client choices in an omnibus account. Trades that settle around the record date complicate matters: the buyer may be entitled to elect while the seller still holds the securities, and the parties must then cooperate so that the buyer's choice is carried out, with any difference settled through a market claim. European market standards address this through buyer protection and a guaranteed participation date.

Controls include diaries of deadlines with escalation, reconciliation of positions before instructions are sent, confirmation of receipt by the next party in the chain, and standing instructions for clients who always make the same choice.

The options are frequently not equivalent. In some countries a share alternative is taxed differently from a cash dividend, or is not subject to withholding. Electing shares increases the holding without dealing costs but may leave the investor with a fraction settled in cash. Custodians do not give advice; they pass on the terms through the custody chain and act on whatever asset servicing instruction the account holder gives.