How you can gain from Sebi's new ESOP regulations

If your company has offered its shares to you under any reward/incentive programme, get ready for big changes in rules that govern these instruments. The Securities and Exchange Board of India, or Sebi, has overhauled the regulations governing Employee Stock Option Plans (ESOPs).

The changes have been made keeping in mind safety of investors and international best practices. Offering of shares to employees as part of an incentive programme is often a tool for insider trading and other fraudulent practices. Sebi has taken steps in the past to restrict such activities.

We look at the recent changes in ESOP regulations and how they impact the beneficiaries.

ESOP trusts can now buy from secondary market: Sebi has proposed that employee welfare trusts be allowed to buy shares from the secondary market. Last year, the regulator had banned this in apprehension that companies may use

ESOPs as a tool for insider trading and other fraudulent practices. The latest order is in line with global practices and aimed atavoiding forced dilution of stake through ESOPs.

However, purchase by the trusts will require shareholders' approval through a special resolution.

"As secondary market acquisitions by trusts is an internationally accepted practice, it (the ban) needed to be reconsidered, subject to necessary safeguards to prevent misuse. This will allow companies/promoters to grant options without diluting their existing shareholding," says Surendra Pareek, partner, tax, KPMG in India.

ESOPs can be issued directly. The shares are allotted when the employee exercises the option. The other route is through a trust, which either acquires fresh shares from the company or buys from the secondary market and transfers to the beneficiaries.

Better safeguards put in place: The new regulations put restrictions on share transactions by employee benefit trusts. Sebi will now specify limits for shares that can be bought by the trusts from the secondary market.

Also, the trusts should hold the shares acquired from the secondary market for at least six months. Besides, they can make only delivery-based transactions and cannot bet on the derivatives market. Sebi will soon come out with stricter disclosure and compliance norms.

New category for stocks held under ESOPs: The new regulations also put stocks held under ESOPs in a category separate from 'Promoters' and 'Public'.

"Sebi has proposed to put ESOP shares in a separate category in order to prevent misuse of employee trusts as an alternative mode of promoter holding. The shares held by the trust cannot be considered as public either," says Inder Mohan Singh, Partner, Amarchand Mangaldas.

Earlier, only Employee Stock Option Scheme (ESOS) and Employee Stock Purchase Scheme (ESPS) were under Sebi regulations. Now, Sebi has expanded the scope of these regulations to other stockrelated employee benefit schemes such as stock appreciation right (SAR) and restricted stock award.

Sebi has put a limit of 10% of assets held by general employee benefit schemes (other than ESOS) on owning shares of the company or the listed holding company.

"By bringing in such unregulated schemes within the purview of the new regulations, Sebi is ensuring enhanced disclosure and protection to investors," says Inder Mohan Singh of Amarchand Mangaldas.

Companies have the flexibility to design employee stock options in many ways. The main ones are:

1) ESOS: The company gives the employee the right to buy its shares (not obligation) a predetermined price. To avail of the option, the employee is required to complete service for a specific period.

2) ESPS: The employee is allowed to buy shares of the company at a discounted price on a predetermined date.

3) Stock appreciation right (Phantom Equity Plan): The employer offers the employee notional shares at a pre-determined price. After completion of a period of service, the former pays the amount by which the shares have appreciated during the period. The employee doesn't have to make any cash investment.

4) Restricted stock award: Here the employer offers stocks subject to certain conditions. The employer has the right to cancel the entitlement if the conditions are not met. The employee is considered to own the shares from the date of the award.