In this blog post, Mansumyer Singh, an advocate and who is currently pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the disclosure and process requirements for ESOP for listed companies.
A company is an association of persons coming together to achieve objects which are either economic or non-economic in nature. The capital of the company is divided into shares which are offered for sale to raise the capital for the company. Shares represent the ownership in a company. Public Companies, to raise capital offer shares for a subscription to the general public by initial public offering and is traded on at least one stock exchange. A Stock Exchange is an exchange where stock brokers and traders can buy or sell stocks, bonds or other securities and may provide facilities for issue and redemption of securities and other financial instruments[1]. Securities traded on a stock exchange include stock issued by listed companies. A company has many employees working to achieve the objectives of the company. To satisfy and enhance the involvement of the employee, a company offers many profit sharing plans. The profit sharing plans are based on predetermined economic sharing rules that define the split of gains between the company as a principal and the employee as an agent. In publicly traded companies, these plans typically amount to the allocation of shares to employees. Employee Stock Ownership Plan (ESOP) is one of such profit sharing scheme.
What is ESOP?
An Employee Stock Ownership Plan (ESOP) is an employee-owner program that provides the employees of the company with advantages and interests equivalent to that of owners. In an ESOP, companies provide their employees with stock ownership, often at no upfront cost to the employees. ESOP shares are a part of employee’s remuneration for work performed by them. Shares are allocated to employees and may be held until the employee retires or leaves the Company. The shares are then either bought back by the company for redistribution or voided. Corporations offering ESOP often allow for company executives to have greater flexibility and control in governing and managing the corporation.
An ESOP is a defined contribution employee benefit plan that allows employees to become owners of stock in the company they work for. It operates through a trust which is set up by the company accepting tax deductible contributions from the company to purchase company stock. The contributions made by the company are distributed to individual employee accounts within the trust. The amount of stock received may vary according to pre-established formulas based on salary, service, or position. Employees receive the vested portion of their accounts at termination, disability, death, or retirement. These distributions may be made in a lump sum or instalments over a period of years. If employees become physically challenged or die, they or their beneficiaries receive the vested portion of their ESOP accounts right away[2].
The definition of term ESOP can be extracted from Rule 12(1) read with Section 2(37) and Section 197(7) of the Companies Act, 2013 which provides the term to mean any permanent employee or Director, whether whole time or not, and whether working in India or not, which also covers the Directors and the employees of the Holding company, Subsidiary company and Associate Company. The definition specifically excludes Independent Director, any employee who is or belongs to the Promoter group or any Director who holds more than 10% of outstanding equity shares of the company either directly or indirectly.
The procedural requirements for setting up an ESOP are stated under Rules 12(1), 12(2) and 12(4) read with Section 62 (1)(b) of the Companies Act, 2013. The process requirement mentions that there should be approval of the ESOP scheme by the member of the Company by way of a special resolution and there shall be separate resolutions in case the ESOP scheme is granted to the employees of a Subsidiary or Holding Company, or it is granted to the identified employees who are equal to or are exceeding 1% of the issued capital of the company.
There is a requirement for explanatory statement which discloses the following prescribed details:-
- Total number of ESOPs to be granted
- Appraisal process
- Requirements of vesting
- Exercise price or the pricing formula
- Exercise period
- Lock-in period
- Method of accounting, etc.
The rest of the sub-rules of Rule 12 also require the variation of terms of the ESOPs which shall be carried out by obtaining members’ approval by a special resolution, but the same shall not be prejudicial to the interests of the employees. The minimum vesting period shall be one year. The non-transferability of the ESOPs shall also be mentioned. It should also mention about where the unvested ESOPs shall be vested in the case of death or permanent incapacity of an employee. There should be proper maintenance of an ESOP Register. There shall also be proper and detailed disclosure of the prescribed details in the Director’s report[3].
In the context of ESOP, Securities Exchange Board of India (SEBI) has notified Securities and Exchange Board of India (Share-Based Employee Benefits) Regulations, 2014 on October 28, 2014. These new regulations have replaced the earlier ESOP guidelines. Some of the key regulations notified by SEBI vide circular dated 16 June, 2015 specifying the necessary guidelines relating to disclosure and process requirements under the new regulations are as follows[4]:-
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Regulation 3(3) – Minimum provisions in Trust Deed
SEBI may specify the minimum provisions which are to be included in the trust deed under which the trust is formed. The trust deed and any modifications to the same shall be mandatorily filed with the stock exchange in India where the shares of the company are listed. SEBI expressly provides the minimum provisions to be mentioned in the trust deed.
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Regulation 5(3) – Terms and Conditions of schemes to be formulated by the Compensation Committee
This regulation states that the compensation committee shall formulate the detailed terms and conditions of the scheme which shall also include the provisions specified by SEBI.
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Regulation 6(2) – Contents of the explanatory statements to the notice and resolution for shareholders meeting
Under this regulation, the explanatory statement for notice of calling a general meeting and the resolution proposed to be passed by the shareholders for the schemes in general meeting shall also specify the information mentioned by SEBI.
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Regulation 10(b) – Information required in the statement to be filed with the Stock Exchange(s)
This regulation mentions that a statement as specified by SEBI about the listing is filed, and the company has obtained as in-principle approval from the stock exchanges. SEBI mentions the details to be mentioned in the statements.
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Regulation 10(c) – Format of notification for issue of shares
As per this regulation, as and when an exercise is made, the company shall notify the concerned stock exchange as per the statement specified by SEBI in this regard, the format of which is now prescribed by SEBI.
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Regulation 14 – Disclosure by the Board of Directors
As per this regulation, in addition to the information, a company is required to disclose in relation to the Employee Benefits under the Companies Act, 2013, the Board of Directors are also required to disclose the details of the schemes being implemented and specified by SEBI in this regard. SEBI has now expressly provided the details which are to be disclosed in the Board of Directors Report and on the website of the Company.
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Regulation 16(2) and 23(3) – Disclosure Document
As per this regulation, no ESOP shall be offered unless the company makes the disclosures which are specified by the SEBI to the prospective employees.
Conclusion
The aforementioned circular has introduced additional disclosure and process requirements for listed companies proposing to go for initial public offering to which the new ESOP Regulations apply which would enable SEBI to obtain information to monitor compliance with the New ESOP Regulations under which SEBI had clarified that listed companies can now use trust route to implement schemes through secondary market acquisitions, without diluting their existing share capital. A strict regulatory framework on setting up and administration of such trusts are specified which limits the secondary market acquisitions that need to be adhered to by the companies. Further, through the New ESOP Regulations, SEBI has widened the coverage of the types of schemes covered under the regulations. The new process/ disclosure requirements notified by SEBI would enable SEBI to obtain information on trusts set up, secondary market acquisitions by companies to monitor compliance with the New ESOP Regulations. The disclosure requirements are mainly in line with the earlier Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 except the disclosure in the Director’s Report, which requires detailed disclosures on the schemes followed by the Company. There are no separate timelines specified for compliance with these disclosure requirements. Hence, listed companies proposing to go for Initial Public Offering would need to comply with these requirements within the timelines specified in the New ESOP Regulations.
Footnotes:
[1]Meaning of Stock Exchange, available at Lemke and Lins, Soft Dollars and Other Trading Activities, (Thomson West, 2013-2014 ed.)
[2]Incentive Plans: ESOP available at http://www.hr-guide.com/data/G446.htm
[3]http://taxguru.in/company-law/esop.html
[4]http://www.kpmg.com/IN/en/services/Tax/FlashNews/SEBI-Circular-on-ESOPs-1.pdf
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