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SEBI reviews ban on employee trusts to buy shares from secondary market for ESOP

21 November, 2013

Within a year of prohibiting employee trusts of public- listed companies to buy shares of their firms from the secondary market as part of employee stock options (or ESOP) schemes (ESOS), market regulator Securities and Exchange Board of India (SEBI) is looking to review the ban. 

SEBI said on Thursday that reconsidering its policy as secondary market acquisitions by trusts is an internationally accepted practice subject to necessary safeguards to prevent misuse. It noted that such transactions allow companies to grant options to employees without having to dilute their existing share capital. 

“Further, it was also recognised that there are many kinds of employee benefit schemes involving own securities which being outside the purview of extant ESOS gGuidelines are unregulated. There is also a need to provide for a suitable regulatory framework for such kind of schemes,” it added. 

It was just in January this year (read here for more) that SEBI had banned such secondary market transactions as it found that some entities may frame such schemes with the purpose of dealing in its own securities with the object of inflating, depressing, maintaining or causing fluctuation in the price of the securities by engaging in fraudulent and unfair trade practices. 

SEBI had asked for details of all such secondary market purchases and sales since April 2012 and said firms would have to comply with the guidelines by June 30, 2013. Later it had extended itt to December 31, 2013.

The securities market regulator has now floated a discussion paper asking for public comments by first week of December, based on which it will take a final call. It also proposes to change the ESOS gGuidelines into rRegulations. 

SEBI had also formed a group with representatives from industry to suggest measures to be included in the proposed regulations. This group has come out with a set of proposals, including schemes which should and should not come under the purview of the norms. 

Here are highlights from the recommendations of the group. 

What types of ESOP schemes should be covered under the proposed new regulations: The group has suggested all employee benefit schemes managed or financed by the company directly or indirectly through a trust. It has added that a separate section should be marked for Stock Appreciation Right (SAR) scheme where a trust purchases shares upon grant of SARs to employees and sells upon vesting of SARs. In such schemes, employees become entitled to receive the appreciation in value arising from sale of shares. But observed that promoters should not be beneficiaries to such SAR scheme and also said the regulations should not cover ‘phantom options’ which do not involve purchase or sale of shares.

Special employee welfare schemes: At present the guidelines do not cover those schemes where benefits like education, scholarship, medical, etc. are provided to employees using appreciation from underlying shares or from other funds like corpus, investment in shares of other companies, mutual fund, besides retirement benefit scheme such as superannuation, PF, gratuity, etc. The group has suggested that all such schemes, including retirement schemes involving securities of the company should be covered under the proposed regulations. 

Who should administer such ESOP schemes: At present, the company itself or a trust created for the purpose are allowed to manage the stock reward system. According to the group, if fresh shares are issued, flexibility should be available for grant of options directly to the employees or though the trust. However, if shares are issued through secondary market purchase, only option should be through the trust mechanism. The idea behind this is that the trust mechanism provides better corporate governance since the shares of the company would not belong to the company, nor would they be under the control of the promoters. Appropriate disclosures to the stock exchanges and investors should be prescribed. 

Purchasing shares from the secondary market: The group has said the trust should be permitted to acquire the shares of the company provided that the trust is administering any of the schemes like ESOP, ESPS, SAR and general benefit schemes for the employees of the company. But a shareholders’ approval to be obtained in such cases subject to a maximum percentage dilution. However, it has added a provision that no approval of shareholders would be required if the purchases are made by the trust out of its own funds/income and no loans are outstanding at the time of purchasing the shares. The thinking behind this is that secondary market purchases avoid dilution of capital and do not impact the value of existing shares in the hands of shareholders like EPS, etc. This is crucial where the option of expansion of capital base is not available to the firm or is not desirable. 

Quantity of shares which can be purchased through the secondary market: The group has said there should be limits on secondary market purchases for both ESOP and non-ESOP schemes. For ESOP schemes, the ceiling on secondary market acquisition should be 2 per cent per annum of the paid up equity capital as at the end of the financial year and subject to an overall cap of 5 per cent of the paid up equity capital. In case of general employees benefit trust, it has said that there should be an overall limit of 2 per cent of the paid up share capital on secondary market purchases and the un-appropriated inventory of the ESOP trust to be capped at 5 per cent of paid up capital at the end of any financial year. It has added that these ceilings shall be applicable for all the employee benefit trusts taken together at the company level and not at the level of the individual trust, if a company has multiple trust and schemes. Gifting of shares by promoters or any other person to the trust should also be permitted. 

Limit on company funding for such secondary market share purchase: The limit on stake acquisition through secondary market automatically provides a check on the level of funding, according to the group and there should not be any specific limits mentioned for company funding. 

Holding period of shares acquired through secondary market: To prevent speculative trading there should be a minimum holding period of six months for shares acquired through secondary market. However, this six-month period shall not apply where shares are transferred to employees pursuant to exercise of stock options/SARs and no off-market transfer should be permitted except to employees pursuant to the scheme, according to the group.

Sale of shares by trusts: There should be flexibility in line with international practices and there should not be a restriction on sale in secondary market for the trusts. It has added that for general employee benefits and welfare trusts, the trust should use its internal accruals/income arising out of dividend on underlying shares, interest on deposits, etc. for undertaking welfare initiatives. The trust should be allowed to sell shares in case of emergency for meeting its own objectives and the money so raised shall be used within a definite period. The trusts should also be allowed to participate in other exits available to shareholders like buy back and open offer. 

Classification of shares held by trusts: The group has made several critical suggestions here while saying that such shares should be counted under promoter holding and within the cap of 75 per cent of total equity. It has said that any trust/scheme which is funded/managed/controlled by the company shall not be eligible to exercise voting rights on the shares of the company held by them. But it has called for providing a ring fence by maintaining that the trustees should neither be subjected to any liability of a promoter nor be required to comply with obligations as promoters with regard to triggering of open offer, breach of creeping acquisition limit and other liabilities under the takeover regulations. Further, no enforcement proceedings shall be initiated against the trust merely because it is categorised as a part of the promoter group. 

Others: The group has asked for flexibility in the rules to allow an employee to continue holding the options even if he/she is transferred or deputed to a fellow subsidiary or associate of the listed company. It has also called for a two-year transition period for firms to migrate and comply with the new proposed regulations.

(Edited by Joby Puthuparampil Johnson)


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SEBI reviews ban on employee trusts to buy shares from secondary market for ESOP

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