SEBI Regulations 2014 on Share Based Benefits – important changes over the ESOPs Guidelines

The new Regulations, though they have many amendments, are in many ways similar in structure with the earlier Guidelines. However, the Regulations now have far wider reach in three major aspects. Firstly, they now specifically also cover share-based benefits such as Stock Appreciation Rights. This is also made clear by the title of the Regulations that now refers to generically sharebased employee benefits other than stock options in place of Stock Options and Stock Purchase schemes. Secondly, instead of providing specifically for how stock options and share purchase schemes should be accounted for, the Regulations essentially provide that the accounting shall be carried out as per the Guidance Note/Accounting Standards of the Institute of Chartered Accountants of India.

Thirdly, now, the Regulations specifically provide for dealing in shares by schemes for employees other than Schemes for stock options/share purchase. The earlier Guidelines were more or less silent on this. As will be seen later, it was found that many such schemes dealt in shares of the Company. The concern was whether these were misused for various purposes. Now the Regulations specifically recognise and permit, subject to conditions and restrictions, purchase and otherwise dealing in shares of the Company.

Finally, the change in the legal status of the law from Guidelines to Regulations also has important implications.

These are discussed in detail hereafter.

Eligible employees The definition of employees has been modified. Employees of associate companies (as defined in section 2(6) of the Companies Act, 2013) are also eligible to such Schemes. Independent Directors are now specifically ineligible. The conditions under which nominee directors of institutions may be eligible have been made more elaborate.

Regulations specifically cover SARs The Guidelines did cover a form of Stock Appreciation Rights (SARs) but this was indirect, and of a particular form only. They focused more on stock option and share purchase schemes. Now, the Regulations provide specifically for Schemes of SARs.

SARs provide for rights for being paid for appreciation in the price of the shares. An employee would thus be given a right to be paid for the increase in the value of the shares from the date when the right was granted to the date when he choses to exercise the SAR. The Regulations provide that he can choose to be paid for the appreciation either in the form of cash or shares.

The erstwhile Guidelines too did provide for cashless exercise of stock options. This involved allotment of shares which would be handed over to a stockbroker. The stock broker would then sell the shares. Of the sale proceeds, the exercise price would be retained by the Company and the appreciation paid to the employee.

The Regulations provide for payment of appreciation directly by the Company without allotting any shares. However, such appreciation can also be paid in the form of shares.

The other features of SARs are similar to stock option/ share purchase schemes. There has to be a waiting period of one year before exercise of the SARs.

General Employee Benefits Scheme (GEBS) and Retirement Benefit Schemes (RBS) Two new categories of Schemes have been now specifically covered. However, such schemes are covered only if they deal or are intended to deal in the shares of the company that they are required to comply with the Regulations.

Such Schemes shall not hold more than 10% of their assets as per the last audited balance sheet in the form of shares of the Company. For this purpose, the book value or market value or fair value of the assets is considered, whichever is the lowest.

To which Schemes are the Regulations applicable? The Guidelines applied to schemes set up by companies for issue of stock options and share purchase. It was not clear whether other schemes that also dealt in shares were also covered. It was seen that there were Schemes that were for the benefit of the Company but were not apparently controlled by the Company or its Promoters but also dealt in the shares of the Company. Under what circumstances would such Schemes be regulated? The Regulations now have specific provisions to deal with this.

Firstly, they apply to Schemes of stock options, share purchase, SARs, general employee benefits schemes and retirement benefit schemes. Such Schemes should involve dealing in the shares of the Company, directly or indirectly. Further, the Scheme should have a link with the Company in any of the following ways:-

(i) the Scheme is set up by the Company or any other company in its group (the term group is widely defined); or(ii) the Scheme is funded or guaranteed by the Company or any other company in its group; or (iii) the Scheme is controlled or managed by the Company or any other company in its group.

The Company of course needs to be a listed company. Thus, companies would be free to set up Schemes for benefit of employees and the employees themselves are free to set up such Schemes without being regulated by SEBI. However, if they deal in the shares of the Company and are connected with the company in any of the specified manner, then they will need to comply with the provisions.

Dealing in shares by share based benefits Schemes As stated earlier, it was observed by SEBI that several Schemes were set up apparently for the benefit of employees but dealt in the shares of the company. They apparently were not connected with the company. They held shares of the Company that were often acquired from the secondary market. There were legitimate concerns that the object of such Schemes was more to carry out illegitimate objects such as surreptitious holding shares on behalf of the Promoters, carry out insider trading or price manipulation, give market support to price at time of fall, etc. This was of even more concern when funds of the Company were directly or indirectly used.

SEBI did issue certain directions to require control this aspect. However, it seems that it was also realised that there may be legitimate reasons why certain Schemes may be required to hold shares of the Company. The Regulations now provide for more transparency and clarity. Such Schemes are now allowed to deal in shares subject to certain restrictions and disclosures.Existing Schemes holding shares are also required to comply after completion of a transition period.

In case it is desired that share acquisition be carried out through secondary acquisition or gift of shares, then such Schemes should be administered through a Trust. There are certain restrictions over appointment of Trustees to such Trusts. Further, in such cases, specific and separate approval of the shareholders by way of a special resolution is required to set up such Schemes.

SEBI lays down limits upto which the trusts administering such Schemes may hold shares. Stock options, share purchase and Sars may not hold shares more than 5% of the share capital of the Company in the year prior to which approval of the shareholders is obtained (as expanded by bonus/rights issues made later). For general benefits and retirement benefits Schemes, the maximum holding is 2%. however, all such Schemes put together cannot hold more than 5% shares. Such limits will not apply in case of gift of shares by the Promoters or other shareholders or where these are acquired by way of a fresh issue of shares.

The   yearly   cap   on   acquisition   of   shares   through secondary market by the trust is set at 2% of the paid up share capital as at the end of the preceding financial year.

In any case, the number of shares acquired through secondary market purchases cannot exceed the grant  of benefits in the form of stock options/share purchase/ Sars. If there are such excess holdings, they will need   to be appropriated within a reasonable period but not beyond the end of the following financial year. There is also generally a lock in period of six months, except for certain specified manner of disposal.

The trustees  of  such trusts  are  prohibited  from  voting on such shares. This will ensure that such shares are not acquired for supplementing the voting power of the Promoters/management.

Further,  the  holding  by  such trusts  will  not  be  counted as part of public holding. Companies would thus be required to maintain the minimum public holding as required by law.

Approval   of   Shareholders Broadly, the requirement of approval of shareholders for such Schemes remain the same as under the Guidelines, i.e., approval should be by way of a special resolution. However, separate approval shall be obtained in certain cases such as permitting acquisition of shares from the secondary market, grant of options etc. to employees of subsidiary/holding/associate companies, etc.

Accounting for stock options, etc.Accounting for discount on issue of stock options, etc. has always  been  a  controversial  issue. the  Guidelines  had provided in fair detail how such discount should be computed and accounted. Companies were required to follow such accounting as a pre-condition for issue of stock options, etc. at a price they chose to determine. However,   it was seen that the accounting provisions were not very detailed particularly to cover the wide variety of such schemes in practice. Further, the accounting method created areas of potential difference between what was recommended by accounting bodies. The Regulations have now simplified the provisions. The accounting for such schemes shall be as per the Guidance note of ICAI or accounting Standards as may be prescribed by from time to time by the ICAI.

The  Guidance  note  of  the  ICAI  on accounting  for  employee Share Based payments covers such accounting requirements.

Transition PeriodCompanies that have existing Schemes are required to comply with the regulations within one year. Trusts holding shares in excess of the limits specified in the Regulations are required to bring down the holding in five years.

Regulations vs. GuidelinesThe erstwhile Guidelines had, at best, dubious sanctity as an enforceable law. Several earlier important provisions relating to securities markets were in the form of Guidelines. It was uncertain to a large extent whether they could be enforced, whether acts/omissions in violation of law could make the transactions void and above all, whether SEBI could initiate adverse measures in the form of adverse directions, penalties and prosecutions against the parties.

As will be discussed later, it appeared that certain Schemes involved dealing in shares and it was felt that these dealing in shares were for purposes other than purely for benefit of employees. It may have been difficult to enforce the Guidelines or punish any violations in such cases.

Issue of the regulations cures these defects. Thus, this is an important change of the provisions relating to share-based benefits.

This  trend  of  changing  Guidelines  into  regulations  is seen in other areas as well and it is expected soon for the provisions in regard to corporate governance.

ConclusionThe  regulations,  while  not  overhauling  the  provisions relating to share-based benefits substantially, do make important changes, remove certain possibilities for abuse align the provisions with the new Companies act, 2013.