SEBI (Share Based Employee Benefits) Regulations, 2014 1. Key Highlights Companies are now allowed to use secondary shares for issuing ESOPs. Use of Equity settled Stock Appreciation Rights are allowed. General Employee Benefit and Retirement schemes involving equity shares of the employer company will now come under the purview of these Regulations. A permanent employee or Director of even an Associate Company has been covered in addition to those of the Company, its Subsidiary and Holding Company. Independent Directors are excluded. Companies using secondary shares will have to use the Trust route. Companies using Trust route will need to appoint independent Trustees Companies are allowed to fund the Trust upto prescribed limits. Trust holding shall neither be disclosed as Public nor Promoter holding but as a separate category. Trust cannot sell shares in market except for prescribed reasons. Trustees shall not have any voting rights on the shares held by the Trust. Accounting for all Equity based benefit plans to be in accordance with Standards issued by ICAI. If the Company doesn t have Trust and not intending to have Trust, no additional compliance is required to be done by the Company in view of the Regulations. 1
SEBI (Share Based Employee Benefits) Regulations, 2014 2. Background 2.1. Securities and Exchange Board of India (SEBI) in appreciation of the internationally accepted practice was considering bringing of a Regulation affording acquisition, deal and use of secondary shares by the Companies for the purpose of implementing their employee benefit schemes which would result in no dilution of existing share capital. Variants of employee share based benefit schemes which were hitherto not regulated in the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 (Guidelines) were also sought to be covered. 2.2. Accordingly, SEBI (Share Based Employee Benefits) Regulations, 2014, (Regulations) have been brought into force with effect from October 28, 2014 repealing the Guidelines which were inforce till then. The Regulations have formally recognized the concept of Stock Appreciation Rights (SAR) Scheme and also embraced the General Employee Benefit Scheme (GEBS) and Retirement Benefit Scheme (RBS) in its ambit in addition to Employee Stock Option Scheme (ESOS) and Employee Stock Purchase Scheme (ESPS), allowing secondary shares acquisition for the implementation of such Schemes in addition to use of primary shares. 2.3. The provisions contemplating use of primary shares are akin to that of the repealed Guidelines, whereas the majority of the provisions that are new relate to acquisition of secondary shares through the Trust route. The mechanism while allowing dealing in secondary shares on one hand prescribes for certain compliances on the other with a view to instill enough safeguard to prevent misuse that has been a concern of SEBI. Other welcome feature of these Regulations is that it is aligned with Guidance Note issued by Institute of Chartered Accountants of India (ICAI) and Companies Act, 2013 on overlapping topics. This should remove ambiguities and ensure consistency in compliance. 2.4. Undoubtedly, these much awaited Regulations have provided clarity in connection with dealing in secondary shares, Trust set-up and management. 2.5. With this News Letter, we bring to you analysis of important provisions of these Regulations. We are also planning to have Webinar on the subject to share the implications and way forward for issuer companies. 3. Applicability These Regulations apply to ESOS, ESPS, General Employee Benefit Schemes (GEBS), Retirement Benefit Schemes (RBS) and SAR Schemes of the listed companies. 3.1. Besides above, Regulations also apply to a listed company having an employee benefit Scheme involving dealing in its securities whether the said Scheme is set-up, funded, guaranteed, controlled or managed by the company itself or by the any other company in its group. Even if a part or whole of the process is owned or controlled by a group company, the Regulation shall 2
have application still on the listed Company if its securities are being dealt with for its employees pursuant to a Scheme. This also infers that any other employee benefit Scheme (other than ESOS, ESPS, GEBS, RBS and SAR Scheme) by a listed Company which involves dealing in securities of the Company by whatever name called is also sought to be covered. 4. Definitions and new features 4.1. Employees and Directors of the Associate Companies of the Company are now included in the definition of employee in sync with the Companies Act, 2013. Moreover, in case of an employee who has been granted benefits under a Scheme is transferred or deputed to an Associate Company prior to vesting or exercise, the vesting and exercise as per the terms of grant shall continue in case of such transferred or deputed employee even after the transfer or deputation. 4.2. Independent Directors have been specifically excluded as provided in the Companies Act, 2013. 4.3. Group has been defined in the context of application of these Regulations (as aforesaid) to a Company. 4.4. GEBS may be implemented for the purpose of employee welfare including healthcare benefits, hospital care or benefits, or benefits in the event of sickness, accident, disability, death or scholarship funds, or other like benefits for the employees. 4.5. Grant date for accounting and compliance purposes is defined as the date of the compensation committee meeting approving the grant. 4.6. RBS may be implemented for providing retirement benefits to the employees. This may include a retirement savings plan. 4.7. SAR Scheme may be implemented to provide net appreciation of over certain number of shares (corresponding to the number of rights granted) by way of cash or shares. It may be noted that an SAR Scheme providing for only cash settlement and not involving dealing in the securities of the Company in any manner shall not be within the ambit of these Regulations. The SAR mechanism offers same amount of benefit to the employees with lesser dilution of capital vis-àvis ESOS or ESPS. 5. Implementation through Trust Trust set-up 5.1. Decision about use of Trust route has to be taken at the time of taking Shareholders approval for the Scheme. This connotes that the Company should take all material decisions on Trust set-up and administration before calling a general body meeting. 3
5.2. The Trust (existing or new) should be irrevocable. The Trust Deed shall contain minimum provisions prescribed by SEBI (not yet prescribed). The Company has to file a copy of the Trust Deed with the Stock Exchange(s) on set-up of the Trust and on any modification to the Trust Deed. 5.3. Regulations prohibit a Promoter, Director, Key Managerial Personnel (e.g. a Chief Executive Officer, Chief Financial Officer, Company Secretary, etc.), of the Company or its Holding/Subsidiary/ Associate Company or any relative of such persons, or a person holding 10% or more in the paid-up capital of the Company, from being a Trustee. The Regulations also contemplate appointment of corporate entity as a Trustee indicating the concept of Independent Trustee. 5.4. Regulations expect certain due diligence on the part of the Trustees like that they have to ensure that appropriate approvals are in place in connection with the implementation of the Scheme. This indicates that Trustees are expected to be conversant with provisions of these Regulations. Acquisition and holding by the Trust 5.5. There is no restriction on quantity of shares that can be subscribed by the Trust by way of primary issue of shares or shares offered as gift from promoters or other shareholders. 5.6. As far as acquisition of secondary shares is concerned, the Trust procure shares within the ceilings given below: S. No. A B Particulars Annual acquisition for any or all Schemes Shareholding at any point in time (i) For all GEBS and RBS taken together (ii) For all ESOS, ESPS and SAR Schemes taken together (iii) For all the Schemes taken together Ceiling Not exceeding 2% of the paid-up equity capital as at the end of the previous financial year (FY) Not exceeding 2% of the paid-up equity capital as at the end of the FY immediately preceding the year in which shareholder approval is obtained Not exceeding 5% of the paid-up equity capital as at the end of the FY immediately preceding the year in which shareholder approval is obtained For instance, one or more Schemes got approved contemplating use of secondary shares in December 2014. Assuming number of paid-up equity shares as on March 31, 2014 to be 100 Million, the overall ceiling for all the Schemes would be 5 Million secondary shares. This overall ceiling gets frozen. However, the annual acquisition ceiling for acquisition in FY 14-15 is 2 Million secondary shares and is subject to change every subsequent FYs depending on paid-up equity capital position at the end of FY preceding the year of acquisition. 4
The overall ceiling computed above are subject to appropriate adjustments in case of corporate actions including the issue of bonus/rights shares and share split. Further, the above ceiling limit will not be applicable where Shares are allotted to the Trust by way of gift from promoter or promoter group or other shareholders. 5.7. Any existing Trust which is holding shares above the permissible limits should comply with these regulations in next 5 years. 5.8. Shares held by the Trust shall be shown separately as Non-promoter and Non-public shareholding with no voting rights to the Trustees. 5.9. Any existing Trust shareholding shown either as Promoter or Public shareholding hitherto, can continue to disclose under the same category up to next 5 years. Going forward, the Trust shareholding shall not be considered for the purpose of public shareholding which needs to be maintained at a minimum of twenty five per cent as prescribed under Securities Contracts (Regulation) Rules, 1957. 5.10. Trust shall not hold shares exceeding 10% of the total value of all assets with the Trust in case of GEBS and RBS. Disposal of shares by the Trust 5.11. The Trust shall not dispose of the secondary shares for a minimum period of 6 months from the date of acquisition of share in reference. This indicates that in case of acquisition in tranches at different points in time, 6 month period shall apply to individual acquisitions preferably on FIFO basis. The minimum holding period criteria of 6 months shall not apply in case the Trust participates in an open offer as per SEBI Regulations, buy-back/ delisting/ other exits offered by the Company that is generally offered to the other shareholders all in off market mode. 5.12. The secondary shares held by the Trust not backed by grant (outstanding Options) need to be disposed of latest by end of subsequent financial year. The time limit commences from the date when the count of secondary shares held by the Trust exceeds the grants as on that date. This occasion may arise on: i. Acquisition of secondary shares in excess of corresponding grant of Options/ SARs; and ii. Lapse or cancellation of outstanding Options/ SARs (on termination of employment or otherwise) in the meantime. If an existing Trust is not able to dispose of un-backed inventory of shares by October 28, 2015, this fact shall be disclosed to the Stock Exchange(s) in which case, those shares shall be disposed of through Stock Exchange(s) by October 28, 2019. 5.13. Off market disposal of shares is allowed in case of (i) transfer of the shares to the employees as per Scheme terms, and (ii) Trust participates in an open offer as per SEBI Regulations, buy-back/ delisting/ other exits offered by the Company that is generally offered to the other shareholders. 5.14. Trust shall not dispose of shares in the secondary market except for facilitating cashless exercise of Options, ensuring realization of appreciation under SARs, meeting any emergent financial 5
needs of the Trust (in case of GEBS or RBS), participation in a general buy-back / delisting offer, winding up of the Scheme, and in case SEBI approves on Application of the Company. Funding to Trust 5.15. Irrespective of subscription of primary shares or purchase of secondary shares by the Trust, the manner, mode and ceiling of funding by the Company to the Trust are subject to the provisions of the Companies (Share Capital and Debenture) Rules, 2014. 5.16. The said Rules mandate that the value of shares to be subscribed and/or purchased shall be subject to the limit of 5% of the paid-up capital and free reserves. The reference date for calculating the ceiling is not specified in the Rules. The Companies Act, 2013 defines the term free reserves referring to the amount as per latest audited balance sheet. The ceiling may be accordingly computed. 5.17. The said Rules require that Company has to get approval of shareholders by way of special resolution and the explanatory statement thereof shall disclose certain prescribed particulars about the Trust. Trust accounting and Disclosures 5.18. As per Regulations, the Trust shall keep and maintain proper books of account, records and documents, for each Scheme so as to explain its transactions, disclose at any point of time the financial position of each Scheme, and in particular to give a true and fair view of the state of affairs of each Scheme. 5.19. In case, the Trust has received any loan, or guarantee thereof from the Company, the company has to disclose certain particulars as prescribed in the Companies (Share Capital and Debenture) Rules, 2014, in its Directors Report. 6. Untouched provisions of the Guidelines 6.1. Flexibility to use Trust route in case of use of Primary shares. 6.2. All the common features and aspects of ESOS and ESPS Schemes namely grant by Compensation Committee, the minimum vesting/ lock-in period, freedom to determine the exercise/base price, transferability of an Option, treatment of outstanding options in case of termination of employment, variation of terms of the Schemes, listing of shares (in case of primary issue), disclosure to employees at the time of grant, etc. have remained unchanged. 6
7. Stock Appreciation Rights This instrument which is in line with global practice, has been specifically allowed now and can be implemented through Primary issue or Secondary market acquisition. 7.1 All the features and aspects of ESOS Schemes namely grant by Compensation Committee, the minimum vesting/ lock-in period, freedom to determine the exercise/base price, transferability of an Option/ SAR, treatment of outstanding options in case of termination of employment, variation of terms of the Schemes, listing of shares (in case of primary issue), disclosure to employees at the time of grant, etc. will apply for SAR s 8. Accounting Policies 8.1 Guidance Note on Accounting for employee share-based Payment (Guidance Note) issued by Institute of Chartered Accountant of India (ICAI) should be followed for Accounting and amortization of cost in books of accounts. 8.2 Though the methods of accounting of employee compensation cost broadly remains similar in Guidance note vis-à-vis earlier guidelines, going forward accounting entries may vary as Companies converge to Guidance note. 8.3 It also now clear that Trust accounts need not be consolidated with the Company as it is not required under the Guidance Note. 9. Transition With the introduction of New Regulations, SEBI has repealed the earlier Guidelines with immediate effect. 9.1 All Listed Companies have to comply with these Regulations within one year, subject to following exceptions: a) Trust holding shares beyond permissible limit have 5 years to bring down its holding. b) Trust holding shares for the purpose of implementing GEBS or RBS, which exceeds 10% of the Total Value of the assets shall have 5 years to bring down its holding Trust disclosing their holdings under promoter or public, shall be permitted to continue to disclose them as such for a period of 5 years. 7
10. Concluding remarks Notification of Regulations is a welcome step. Apart from giving more flexibility to companies for sourcing secondary shares and funding the Trusts, as Regulations these provisions will now enjoy much more enforceability than erstwhile Guidelines. The Regulations seek to balance flexibility and relaxation with exhaustive disclosures and controls thereby ensuring fairness. Allowing use of secondary shares is a big relief for companies which are constrained with dilution pressures. It also demonstrates willingness of SEBI to listen to Corporate India with an open mind and its readiness to go back on its stand on banning secondary shares. There are, however, quite a few loose ends in the Regulations and we hope that suitable clarifications / circulars would be issued by SEBI soon to close them. Issues that need clarifications are as follows: o Applicability of the Regulations in case a Scheme is set-up, funded, guaranteed, controlled or managed by a group of the Company of a listed Company. o Minimum provisions in a Trust Deed. o Powers or duties of Compensation Committee. o Manner of adjustments in case of corporate action. o Disclosure requirements in the explanatory statement to the special resolution seeking approval of the Scheme and Trust. o Disclosure requirements in the Directors Report. o Format/timing for applying to the stock exchange in connection with in-principle approval or listing of shares. o Disclosures to be made to the prospective option grantees. 8
About ESOP Direct ESOP Direct is a leading solutions company in the space of Equity based compensation. ESOP Direct is a team of 50+ professionals. Our expert team of professionals brings experience in the preliminary analysis, planning, designing and implementation of ESOPs. Each of our consulting team members is a qualified Chartered Accountant/Company Secretary. The team also consists of CPAs and Management graduates including qualified CEPs (Certified Equity Professional) on board. CEP is a US qualification highly recognized in Equity based compensation space globally. About our Services Our service offerings cover the entire life cycle of ESOPs including Plan Design Plan management Compliance and reporting Options Valuation and Accounting disclosures ESOP Trustee and Trust management FEMA and Income tax advisory We are the first and the only company in India to offer a full spectrum of integrated on-line stock plan management services, including plan administration, compliance, employee communication and online transaction capabilities. This service is delivered using our proprietary platform My ESOPs. At ESOP Direct we also offer a web based platform for financial reporting of stock options which includes valuation, expensing and reporting under IFRS, IGAAP & FAS 123R. About the write-up We hope that you find the information in this newsletter useful for the understanding of SEBI (Share Based Employee Benefits) Regulations, 2014. In addition, you should be aware that the information provided in the newsletter is presented in a general format and is not a comprehensive summary of the new Regulation. With these factors in mind, it is important that you do not consider this note to be legal advice and do not rely solely on the information provided in the newsletter. We would be pleased to help you review all pertinent information and can assist you in developing a comprehensive strategy to implement Share based employee benefits plan for your employees. For More Information If you have any questions about the design, implementation, and maintenance of equity compensation programs, please contact : T: +91 20 6652 5284/85 consulting@esopdirect.com ESOP Direct KP Corporate Solutions Limited KPIT Cummins Campus Plot 35-36, Rajiv Gandhi Infotech Park MIDC Phase -1, Hinjewadi Pune, Maharashtra 411057 INDIA www.esopdirect.com Offices at; NCR Mumbai 9