Employees Stock Options

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ESOPs, “Employees Stock Ownership Plans” or “Employees Stock Options Plans” is the generic term for a basket of instruments and incentive schemes provided to the employees of the company to motivate, reward, remunerate and to retain the employees. These are rather modern way of motivating employees as against the age old method of compensating the employees with salaries alone. It is now an accepted practice for large entities to remunerate their employees, apart from salary, by the way of granting options to the employees to acquire the shares, hence a portion of the ownership, of the company for which they work. This is believed to motivate employees as they can closely relate their success with the success of the entity for which they work.

Sub-section 37 of Section 2 of Companies Act 2013 gives the definition of stock option. It states “employee’s stock option means the option given to the directors, officers, employees of a company or of its holding company or of its subsidiary company, if any, which gives such director, officer or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at the future date at pre-determined price.”

SEBI Guidelines on ESOP 

  1. Introduction

Security and Exchange Board of India issued Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme), Guidelines, 1999 under section 11 of the Securities and Exchange Board of India Act, 1992 to provide guidance as to granting options or shares to employees under ESOS or ESPS by listed companies.

These guidelines are contained in two parts. Part one deals with Employee Stock Option Scheme [ESOS] which is other name for Employee Stock Option Plan. Part two deals with Employee Stock Purchase Scheme [ESPS] or Employee Stock Purchase Plan [ESPP]

  1. Applicability

As per the clause 3 of the guidelines, these guidelines apply to any company whose shares are listed in a recognised stock exchange. An unlisted company in process of listing may also grant options or shares after the unlisted company makes initial public offering and after its shares are listed subject to fulfilment of certain requirements stated in clause 22 of the guidelines.

  1. Non Applicability

The SEBI Guidelines are not applicable to the following ESOP Schemes: –

  • ESOP structured by unlisted Companies.
  • Share issued by the company to the Trust under ESOP by listed companies prior to 19th June 1999.
  • ESOP structured by companies not listed in India.
  1. Eligibility

As per the clause 4 of the guidelines an employee is eligible to participate in the ESOS. As per clause 2.1.1 of the guidelines the following persons are covered in the definition of employee

  • Permanent Employees in India or abroad
  • Whole-time Director
  • Other Director
  • All of above of subsidiary or holding company in India or abroad.

Meaning of Employee Stock Option Scheme

As per the clause 2.1.3, “employee stock option scheme (ESOS)” means a scheme under which a company grants employee stock option. At the same time as per clause 2.1. 2A “employee stock option” means the option given to the whole-time Directors, Officers or employees of a company which gives such Directors, Officers or employees, the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a predetermined price The term securities have not been defined in the guidelines. However as per clause 2.1.14 “share” means equity shares and securities convertible into equity shares and shall include American Depository Receipts (ADRs), Global Depository Receipts (GDRs) or other depository receipts representing underlying equity shares or securities convertible into equity shares.

Constitution of Compensation Committee

The first point of introduction of ESOS is constitution of Compensation Committee as clause 5 of the guidelines specifically requires that no ESOS can be offered unless the disclosures, as specified in Schedule IV {herein after referred to as disclosure document}, are made by the company to the prospective option grantees and the company constitutes a Compensation Committee for administration and superintendence of the ESOS. For this a meeting of Board of Directors is required to be convened in which a committee of Directors majority of whom are independent directors is constituted. The term independent director has been defined in the clause 2.9 as a director of the company, not being a whole time director and who is neither a promoter nor belongs to the promoter group.

Key Responsibilities of the Compensation Committee

The key responsibilities of the ESOP Compensation Committee include the following:

  • To formulate ESOP plans and decide on future grants: The Compensation Committee will decide the overall plan of ESOP. This has to be done with due care and has to be such that it is acceptable to employees, management and shareholders.
    • To identify the employees eligible to participate in the scheme of ESOS: The CC will have to identify the employees to whom the options would be granted. These employees however, need to eligible employees as per the guidelines. Therefore, care should be taken to ensure that no grants are made to temporary employees, promoters or person belonging to promoter group, or a director who either by himself or through his relative or through any body corporate, directly or indirectly holds more than 10% of the outstanding equity shares of the company. Moreover, they will also decide if the grants should also be made to the employees of holding or subsidiary company.
    • To decide the quantum of option to be granted under ESOP Scheme(s) per employee and in aggregate. SEBI guidelines do not prescribe any restriction on quantum of shares that can be allotted to each employee or on aggregate basis. However, grant of option to identified employees, during any one year, equal to or exceeding 1% of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option requires approval of shareholders by way of separate resolution in the general meeting as per clause 6.3. Moreover, as per the Rules notified by central government the cumulative grant of options to employees by a company shall not exceed 15% of the issued capital of the company or 5 crores of rupees whichever is higher at any point of time except with the prior approval of the Central Government.
    • To formulate terms and conditions on followings under Employee Stock Option Schemes of the Company
  1. the conditions under which option vested in employees may lapse in case of termination of employment for misconduct;
    ii. the exercise period within which the employee should exercise the option and that option would lapse on failure to exercise the option within the exercise period;
    iii. the specified time period within which the employee shall exercise the vested options in the event of termination or resignation of an employee;
    iv. the right of an employee to exercise all the options vested in him at one time or at various points of time within the exercise period;
    v. the procedure for making a fair and reasonable adjustment to the number of options and to the exercise price in case of rights issues, bonus issues and other corporate actions;
    vi. the grant, vest and exercise of option in case of employees who are on long leave; and
    vii. The procedure for cashless exercise of options.
    viii. Any other matter, which may be relevant for administration of ESOP Schemes from time to time
  • To frame suitable policies and systems to ensure that there is no violation of Securities and Exchange Board of India (Insider Trading) Regulations, 1992 and Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market) Regulations, 1995, Companies Act, 2013.
    • Other key issues as may be referred by the board.

Approval of the Shareholders

No public company shall offer ESOS to its employees unless the shareholders of the company approve ESOS by passing a special resolution in the general meeting.

In fact before an ESOP is implemented, three approvals are at least required and those are from Board of Directors, Compensation committee and Share holders. Moreover, the approval of shareholders are also required in any variation is sought to be made in already approved scheme and where any employee of holding or subsidiary company is granted the options under the scheme or where the grant of option to identified employees, during any one year, equal to or exceeding 1% of the issued capital of the company.

The explanatory statement to the notice for approval of an ESOS under section 102 of Companies Act 2013 must contain the detailed information regarding:

(i) The total number of options to be granted;

(ii) Identification of classes of employees entitled to participate in the ESOS;

(iii) Requirements of vesting and period of vesting;

(iv) Maximum period within which the options shall be exercised;

(v) Exercise price or pricing formula;

(vi) The appraisal process for determining the eligibility of employees to the ESOS;  (vii) Maximum number of options to be issued per employee, etc.

(viii) a statement to the effect that the company shall conform to the accounting policies specified in clause 13.1;

(ix) the method which the company shall use to value its options whether fair value or intrinsic value;  (x) the following statement: ‘In case the company calculates the employee compensation cost using the intrinsic value of the stock options, the difference between the employee compensation cost so computed and the employee compensation cost that shall have been recognized if it had used the fair value of the options, shall be disclosed in the Directors report and also the impact of this difference on profits and on EPS of the company shall also be disclosed in the Directors’ report.

The notices for this meeting are generally given only after the compensation committee has prepared a draft scheme for approval of shareholders. This special resolution is also necessary to comply with the provisions of the section 62 of the Companies Act, 2013.

Besides, the above approval, clause 6.3 of the guidelines also require a separate approval of shareholders in case the options are granted to employees of subsidiary or holding company and, where the grant of option to identified employees, during any one year, equal to or exceeding 1% of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option.

Vesting and Vesting Conditions

Under ESOS, generally, employees are given option to purchase stocks of company at reduced price, the act of giving option is called grant of option. However, these options may not be available immediately. Often the rights under the scheme of ESOS are conditional. Fulfilment of such condition is called vesting. As per clause 2.1 (15) “vesting” means the process by which the employee is given the right to apply for shares of the company against the option granted to him in pursuance of ESOS.  Vesting conditions need to be satisfied by the employee in order to be entitled to receive the shares or cash as the case may be depending on the type of plan. Vesting conditions can be classified into:

  1. a) Service Conditions – these require the employee to complete a specified period of service for the options to vest.
  2. b) Performance conditions – these require the fulfilment of certain performance parameters individual or company specific, for the options to vest.

Lock in Period is the period during which the employees of the company cannot sell or transfer the rights in the shares which have been allotted to him under the ESOS. The guidelines do not prescribe any lock in period. Therefore, the companies’ have their own freedom to fix restriction on transfer of the shares by the employees after the shares have been allotted to them under ESOS.

Role of Board of Directors

The Board of Directors (BOD) of the company granting shares to its employees under ESOS plays a very important role in successful formation, implementation and conclusion of the scheme. They perform following essential functions

  • They convene a meeting and constitute a compensation committee, majority of who are independent directors, for successful implementation of the scheme.
  • Before grant of option under ESOS, the BOD shall have to ensure that the employees are informed about the following though ESOS document or separate document:
  1. i) Business of the company which includes history, main business and present business.
  2. ii) Abridged financial information for five years preceding the date of finalisation of ESOS.

iii)Last audited account of the company

iv)Management perception of the risk factor

  • The BOD of company introducing the scheme for the first time must appoint a registered merchant banker for implementation of ESOS/ESPS as per the SEBI guidelines.
  • Allotment of the shares in consultation of merchant banker to employees who have properly exercised the options.
  • BOD should file return of allotment with the registrar of the Company
  • The BOD have to ensure that disclosures regarding ESOS as stipulated in the SEBI guidelines are mentioned in the directors report for the Annual Report to be sent to shareholders.
  • They should place before shareholders at each AGM a certificate from Auditors of the company certifying that the scheme has been implemented as per the SEBI guidelines and as per the resolution of the company as passed in general meeting
  • BOD will have to ensure that the copies of notices, explanatory statements, circulars, annual Director’s Report, annual accounts, etc. That are sent to members are also sent to the grantees under the ESOS as a measure of continuous disclosures.
  • BOD should ensure that the company should file the ESOS/ESPS through Electronic Data Information Filing and Retrieval System (EDIFAR)
  • BOD should ensure that until all options granted in the three years prior to the IPO have been exercised or have lapsed, disclosures is made either in the Directors’ Report or in an Annexure thereto of the information specified in SEBI guidelines in respect of such options also.
  • BOD should also ensure that until all options granted in the three years prior to the IPO have been exercised or have lapsed, disclosure is to be made either in the Directors’ Report or in an Annexure thereto of the impact on the profits and on the EPS of the company if the company had followed the accounting policies specified in SEBI guidelines.
  • BOD will have to ensure that the company follows the accounting policies as specified in the guidelines.

Modification of terms

In case the company at a later stage wants to modify/alter any conditions. As per clause 5 of regulation 7 a company may re-price the options which are not exercised, whether or not they have been vested if ESOSs were rendered unattractive due to fall in the price of the shares in the market. However, the company must ensure that

  • such re-pricing should not be detrimental to the interest of employees and
  • Approval of shareholders in General Meeting has been obtained for such re-pricing.

Non Transferability of Options Option granted to an employee shall not be transferable to any person as they are in nature of personal benefits and no person other than the employee to whom the option is granted shall be entitled to exercise the option. Under the cashless system of exercise, the company may itself fund or permit the empanelled stock brokers to fund the payment of exercise price which shall be adjusted against the sale proceeds of some or all the shares, subject to the provision of the Companies Act.   The option granted to the employee shall not be pledged, hypothecated, mortgaged or otherwise alienated in any other manner.

  • In the event of the death of employee while in employment, all the option granted to him till such date shall vest in the legal heirs or nominees of the deceased employee. In case the employee suffers a permanent incapacity while in employment, all the option granted to him as on the date of permanent incapacitation, shall vest in him on that day.
  • In the event of resignation or termination of the employee, all options not vested as on that day shall expire. However, the employee shall, be entitled to retain all the vested options.

SEBI Guidelines on Employees Stock Purchase Scheme 

Employee Stock Purchase Plan (ESPP) means a plan under which the company offers shares to employees as part of a public issue or otherwise. The Security and Exchange Board of India (Employees Share Option Scheme and Employees Share Purchase Scheme) Guidelines, 1999 regulates the grant of ESPS by the listed companies to its Employees under the scheme.

Under the scheme of ESPS, employees are outright given stocks of the entity at discounted price. Unlike ESOS, there is no option in this case. As in case of ESOS, all permanent employees, whole time or executive directors and employees of holding or subsidiary company of the entity are eligible to participate in the scheme ESPS. Only promoters, person belonging to promoter group and a director who either by himself or through his relative or through a body corporate, directly or indirectly holds more than 10% of voting rights in the company shall not be eligible to participate in the ESPS. ESPS can be offered to employees only after the approval of shareholders of the company by passing special resolution in the meeting of the general body of the shareholders.  The explanatory statement to the notice specify the price of the shares and the number of shares to be offered to each employee and the appraisal process for determining the eligibility of employee for ESPS. The number of shares offered may be different for different categories of employees. Company can fix the price and lock in period. But listed companies would be required to have minimum lock in period of 1 year. Moreover, as per central government rules, the company shall ensure that in the case of Directors, CEO, CFO and any employee to whom a cumulative ESPS issue of 1% or more of the issued capital has been made, a minimum period of two years should elapse between the date of issue of shares under ESPS and the date of sale of these shares. Detailed disclosures are required in the director’s report.

Author: Miss. Ruchika Adlakha, Student, BA LLB HONS, University School of Law and Legal Studies GGSIPU, DWARKA

Intern: Kaden Boriss Partners, Lawyers

Gurgaon, India