Gammon Gold sees class action claim

Gammon Gold (GAM-T, GRS-X) is denying allegations of stock-option manipulation in response to an $80-million class action lawsuit that may be the first of its kind in Canada.

In addition to the options claims, Gammon Gold investor Ed McKenna is suing the company, its execu- tive, directors and three underwriting financial institutions, for making unrealized production forecasts leading up to a $200-million public offering in April 2007.

Options, used to reward good management, can be manipulated in two ways: Backdating is when the option grant date is changed retroactively to a date when the stock price was at a low point; Springloading is when the options grantor has positive, undisclosed information about the company, which would cause a rise in share price if publicized.

McKenna’s statement of claim alleges that, “In a striking pattern that could not plausibly be the result of chance. . . grant dates of stock options charted below were either immediately followed by a sharp increase in Gammon’s stock price, and/or coincided with a date on which Gammon’s stock price was at or near a monthly low.”

The price of Gammon’s stock began to tank shortly after the $20-per-share financing last April, when the company’s first-quarter results revealed that the Ocampo and El Cubo gold-silver mines in Chihuahua state, Mexico, were nowhere near reaching the projected production of 400,000 gold-equivalent oz. per year.

Gammon shares, which have a 52-week rolling high of $21.03 and a low of $5.80, had recovered to $10.17 on March 13, before the lawsuit was announced, but fell more than $1 per share following the news.

Gammon has refuted all allegations and has called the lawsuit a copycat claim of a complaint filed with a New York court last summer over the forecasting issue.

“The company denies the plaintiff’s allegations that it misled investors with respect to production run rates,” said Gammon CEO Rene Marion in a statement.

The company also says there’s nothing wrong with the way it has granted options, with an independent review by Halifax, N. S. law firm McInnes Cooper concluding that Gammon didn’t break any Toronto Stock Exchange rules or securities laws. Gammon initiated the review after it was contacted by McKenna’s lawyer, Dimitri Lascaris, of Siskinds, Cromarty Ivey & Dowler in London, Ont., who cited concerns over the company’s stock options practices.

“There have been no violations of the (options) plan or of the rules of the TSX or applicable securities laws in the granting, pricing or reporting by Gammon of the options granted,” Marion said. “No past or present directors, officers or other employees of Gammon could have profited from any improper exercise of options.”

Gammon has not made the McInnes Cooper report available to the public, or to Lascaris or his client.

“We have made it abundantly clear to McInnes Cooper and the company that we would like a copy,” Lascaris says.

But Siskinds and lawyers from Toronto-based Cavalluzzo Hayes Shilton McIntyre & Cornish, have already cast their net on a much bigger scale. The firms say they looked into more than 900 TSXlisted companies over the last year and a half for options manipulation. Their allegations? That there’s a 95% probability that 35 companies backdated their options between 1987 and 2006.

“We found that this practice appears to have been particularly prevalent in the resource sector,” Lascaris says.

It was a crackdown on options manipulation in the United States that prompted Siskinds to investigate in Canada.

The repercussions have been heavy south of the border. A former Brocade Communications Systems (BRCD-Q) human resources manager was sentenced to four months in prison on March 19 and ordered to pay US$1.25 million for her role in stock options backdating, while her former boss was sentenced to 21 months in prison and fined US$15 million last August.

Things are a little different in Canada, where Lascaris says this could be the first class action lawsuit involving options manipulation.

“We don’t have anywhere near the enforcement of securities law as they do in the United States and as a result there has been very little action on the regulatory front,” he says.

Toronto-based property services company FirstService Corp. (FSV-T, FSRV-Q) mentioned it had paid a US$3.3-million charge in its 2007 third-quarter report for backdated options between 1995 and 2007, while Research in Motion (RIM-T, RIMM-Q) took a US$250-million charge for backdating and caused one of the company’s co-CEO’s to step down as chairman of the board.

Carolyn Shaw-Rimmington, assistant manager of public affairs at the Ontario Securities Commission, says the OSC reviews options timing on an ongoing basis and that some issuers have already been referred to enforcement.

“We typically look at the timing of options grants as part of our continuous disclosure review program,” Shaw-Rimmington wrote in an email.

She said the commission does not comment publicly on the existence, status or nature of an investigation until it becomes one of public record.

Siskinds is taking on the matter in its own way. On behalf of institutions and individual investors, the law firm has sent letters to nearly 25 companies, which it won’t name, demanding appropriate remedial action.

Lascaris only partly blames what he calls lax securities laws in Canada. He also alleges that there’s a certain attitude that prevails in the resource sector — making options manipulation especially prevalent.

“It may be related to the risk-taking culture. . . There are a lot of companies whose fortunes rise and fall overnight on very substantial investment,” Lascaris says. “People are much more concerned about short-term gain than long-term value growth that you might find in the financial sector.”

It will be up to courts to evaluate Gammon’s independent review — and that could take a number of years. Lascaris estimates the class action lawsuit could take three to five.

In the meantime, Gammon will work on becoming a profitable company.

Right now, Gammon’s third management team in a year is working to turn operations around. The company has been proactive about communicating with the public, putting out monthly operations updates.

Scotia Capital analyst Trevor Turnbull, who cannot comment on the lawsuit because his firm participated in the financing, says that Gammon is heading in the right direction.

“It’s the third (management) team in the last twelve months but Rene (Marion) is an extremely experienced and competent operator from his experience with Barrick Gold,” Turnbull says. “What we’ve seen so far is that he’s addressed operational issues.”

Gammon has long since abandoned the goal ofproducing 400,000 gold-equivalent oz. per year and is now focused on becoming cash positive.

Originally, the company expected to accomplish that by the end of the second quarter of 2008 but Turnbull says that could happen by the end of the first quarter.

On March 11, Gammon reported that it was on target to producing in the low to mid-point of the targeted range of 56,000 to 62,000 gold-equivalent oz. over the first quarter at cash costs of US$580-600 per oz.

Turnbull credits the surging gold price, which has saved the company from financial trouble.

“They shouldn’t have to come back to the market (to raise more money),” Turnbull says.

Gammon’s 2007 results were to be released on March 31.

Calls to Gammon’s Halifax office requesting an interview for this story were not returned.