1.

ESOP Trusts in Listed Companies: An Analytical Review

Retention of talented employees is essential for the growth and brand value of the company. The

traditional methods of retaining and motivating employees are no more sufficient to fulfil the self

esteem needs of the Employees.

Employee Stock Option Plan (ESOP) is considered as one of the most contemporary and

important tool to retain human assets of the Company and to reward the high potential

employees. The feeling of ownership acts as a motivational boost for the employees to have long-

term aspirations and association with the organisation.

Background:

Under ESOPs, the options based upon the eligibility criteria of the Employees, are issued to

them, which an employee after the expiry of the specified period, can convert them into the equity

shares of the company and participate in the ownership of the company along with the other

shareholders.

ESOPs in the company can be issued either directly to the employees of the Company (Direct

Route) or through an Employee Welfare Trust (Trust Route

Under the

).

Direct Route, as the name suggests, fresh allotments of the Equity shares of the

company are made to employees, as and when they exercise the options. As against this, under

the Trust Route, the Companies either make fresh allotments of the Equity Shares of the

company to the Trusts or these Trusts, , were authorized to acquire/ buy the shares from the

market as and when they deemed appropriate, and the Equity Shares, so allotted or acquired, by

the Trusts from either of the ways, to be ultimately transferred to the concerned employees, as or

when they exercise the options.

Further some companies also use TRUST to provide the finance facility to the employees in case

at the time of exercise of options, they require fund to make the payments for the options.

Hence the Companies have substantial flexibility to design the ESOPs in any manner catering to

their needs as well as the needs of the Employees, by using either of the alternatives or

combination of both Direct Route and Trust Route

.

Direct Route Trust RouteESOP Issuance Routes

For Listed Entities, SEBI through SEBI (Employee Stock Option Scheme and Employee Stock

Purchase Scheme) Guidelines, 1999 provides an orderly framework to reward their employees

through stock option schemes (ESOPs) and stock purchase schemes (ESPSs). The current

guidelines, already provides enough room to the Companies to frame their Plans and use Trust to

administer it.

However, it was observed by SEBI that some listed entities were taking advantage of these wider

opportunities for framing the ESOP Schemes. As there was no restriction on the purchase of

shares from the secondary market by the Trust for creating a pool of shares for transferring them

to the Employees as and when they exercise, the Market Regulator observed that some

companies had created the Trusts only with the intent to purchase and sell the shares in the

Secondary market under the umbrella of the ESOP Scheme with the sole objective to inflate,

depress, maintain or fluctuate the price of their own shares by engaging in fraudulent and unfair

trade practices, which is a highly debarred act under the securities laws of the country.

Thus, SEBI vide its Circular dated 17th January, 2013 came out with an amendment in the SEBI

(ESOP and ESPS) Guidelines, 1999. Pursuant to the said amendment, SEBI has restrained the

Trust of listed entities to buy shares from the secondary market for creating a pool of

shares for the ESOP Schemes,

2.

and has mandated all listed companies having operational

Employee benefit schemes involving purchase of shares by Trust from open market, to align their

schemes as per the amendment and has further directed to undertake one-time reporting of

certain details vis-à-vis the scheme and dealings in secondary market by the Trusts within a

period of 30 days from the date of the said circular as per the prescribed format.

Our analysis is based on the corpus of disclosures filed with the Stock Exchange(s) as per the

SEBI’s directive, by 30 Listed Entities who have active Employee Welfare Schemes and/ or

Trusts. On analysing the disclosures filed by the Listed Entities, we observed that:

Our Analysis:

•

On analysing the trend related to secondary market purchase by the Employee Welfare

Trusts, it can be inferred that although the prime objective of all these Trusts is to purchase

shares from the secondary market for transferring benefits at later stage to the Employees of

the Company. But, simultaneously, the Trusts might also be selling these shares in the

secondary market during the due course of time that may directly or indirectly influence

market stability and share prices of the company on the Stock Exchange(s). These kinds of

share transactions were leading to creation of a false market.

Approximately 66% of such Companies have formulated Employee Welfare Trust to

purchase shares from the secondary market instead of fresh allotment to the Trust.

•

Almost 36% companies have reported that though they have established Employee Welfare

Trusts but they don’t have actual operational ESOP schemes. The fact that the ESOP Trust

are currently undertaking transactions under the cloak of using them in future under ESOP

Scheme clearly highlights the fact that they were being formed not with the real motive of

transferring shares/benefits to the Employees but are being used for purposes totally

different than employee welfare

Approximately 36% Companies have formed the Employee Welfare Trusts with no backing

of ESOP Schemes:

•

To further elaborate this point

Quite interestingly, approximately 23% of such Companies have Non-Independent Employee

Welfare Trusts and out of which only approx. 21% of such Trusts are been supported by

ESOP Scheme.

, Non-Independent Employee Welfare Trusts are the Trusts

formed for the Employees’ benefit but are been regulated by the Promoters of the company in

the capacity of Trustees of these Trusts. Also as per the disclosure norms of the SEBI, the

identity of the Trustees is the identity of the Trusts.

From the disclosures filed, it has been observed that approximately 79% of the Companies

with Non-Independent Employee Welfare Trusts have actually no operational ESOP

scheme and inference can be drawn that these Trusts are merely acting as marionettes

which are being used for dual purposes, on one hand as a device to facilitate transfer of

shares upon exercise of options by the Employees in future , on other hand can also be used

to safeguard the Promoters Interest in the company.

Furthermore many of these companies are not showing these Employees Welfare Trust as

part of Promoter Group, which again is also a wrong disclosure as per the SEBI disclosure

norms.

The above mentioned Analysis can be depicted with the help of the following diagram:

Secondary Market Purchase

Fresh Allotment

Fresh Allotment cum Secondary Market Purchase

Acquisitionof shares via any other mode

From all the above, it is very clear that the aforesaid practices are not in line with the intents

of the law makers as

3.

the Employee Welfare Trusts are being used as portfolio managers

for the Promoters, which, for obvious reasons, is a non acceptable proposition.

Options made available with the Companies/ Trusts as per SEBI Circular dated 17th

January, 2013:

3.1.

With the objective of aligning the existing Employee Welfare Schemes and working of the

Employees Welfare Trusts, SEBI itself, vide the said Circular, had prescribed the

following two modes for diluting the shareholding acquired by the said Employees

Welfare Trusts from the Secondary Market by 30

The pertinent question that arouse after this circular came into force was what

options would be available to the Companies/ Trusts that are already in existence

and which, till now, had been doing market acquisitions.

th

3.1.1 by transferring shares to the Employees covered under the

ESOP/ESPS Scheme; or

June, 2013:

3.1.2 by selling the shares in the secondary market thereby transferring the

benefits of the Employees.

3.2. How the Companies proposed to deal with the said shares held by the Employee

Welfare Trusts after the Circular dated 17th

January, 2013:

3.2.1 On analysing the disclosures filed by the listed entities, it was observed

that majority of the companies (appx. 82%) have planned to dilute or

to sell the Trust shares in the secondary market through Stock

Exchanges.

3.2.2 Another set of approximately 16% of such listed entities have planned

to approach the Market Regulator either for :-

(a) seeking a clarification with regard to disposal of shares mainly

acquired by the Employee Welfare Trusts pursuant to any scheme

of merger or transfers received from the Trusts of Holding/

Subsidiary Company or through any other mode including market

purchase also; and/ or,

(b) for extension of time from the 30th

June, 2013 for diluting entire

stake held by Employee Welfare Trusts.

3.3. Shortcomings in the mode suggested by SEBI vide Circular dated 17th

SEBI had although suggested the way outs for such Trusts but in our opinion, under both

the options suggested by SEBI, there were certain fall outs, which might need to be

addressed by the Regulator. For instance, if a Company goes in for option 1, i.e.

transferring the shares to the employees, this option would depend upon the life cycle of

the ESOP Scheme of the concerned Company. If the Vesting/ the Exercise Periods have

not expired, the transfer of shares to the employees would not be feasible.

Likewise, for the 2

January,

2013:

nd option, i.e. selling the shares in the Secondary Market, if the said

Trusts put in a large stock for sale in the market, the running scrip prices would plunge

down, thus resulting in fall in the market capitalisation and various other related issues

which can be sighted as a major peril for the capital markets.

Further, the 2nd

3.4.

option may raise various concerns related to accounting aspect for

the substantial loss or gain that may arise on account of bulk selling of the shares

by the Trusts.

SEBI’s initiative to address the apprehensions related to Circular dated 17th

SEBI vide its Circular dated 14

January, 2013:

th May, 2013 has addressed various representations

seeking clarification on the applicability of the Circular dated 17th January, 2013 and the

shortcomings in the modes suggested for dilution of shareholding by the Trusts.

SEBI, keeping in view the representations received, has extended the time-frame for

aligning the scheme in consonance with the SEBI (ESOS & ESPS) Guidelines, 1999 from

30th June, 2013 to 31st December, 2013 with a stipulation that any further grant post

Circular dated 17th January, 2013 shall be strictly in accordance with the SEBI Guidelines.

By appreciating the concerns that have a direct bearing on the Capital Market and at the

public at large, SEBI has allowed Trusts to hold the Securities acquired prior to 17th

January, 2013 beyond the date specified for alignment of the schemes provided that the

schemes have been aligned with SEBI (ESOS and ESPS) Guidelines 1999 and such

securities are used only in accordance with such aligned schemes.

SEBI has further mandated the Listed Entities to disclose further details related to the

Schemes to the Stock Exchanges by June 30, 2013 and in order to keep an eye on the

listed entities, has further casted a responsibility on the listed entities to submit details

related to allotments made or options granted post 17th January, 2013 and up to 31st

4

December, 2013 within 7 days from the end of the quarter.

With the intent to bring transparency in the operations of the Trusts formulated for extending

Welfare Benefits to the Employees, SEBI vide its Circular dated 17

Impact of the SEBI Circular- Our Viewpoint

th January, 2013 restricted the

Employee Welfare Trusts to buy shares from the secondary market and to dilute their existing

holding by 30th June, 2013. In this regard, upon receipt of various representations seeking

clarification on the applicability of the Circular and for extension of time period for dilution of

shareholding by the Trusts, SEBI has further come out with the subsequent amendment in order

to address various ambiguities for dilution of shareholding by the Trusts and its impact on the

Capital Market. With this initiative of SEBI, it can be said that the SEBI has addressed almost all

the commercial difficulties to create hassle free corridor for the Listed Entities on one hand and

protected interest of public at large on the other. However, certain issues related to the holdings

of the Employee Welfare Trusts that are not been backed by any operational ESOP/ESPS

Schemes, still need to be addressed.

From all the above, it can be concluded that like two sides of a coin, SEBI’s Circulars are

surely considered as a welcome step for putting an end to the unfair practices being

followed by some listed entities under the garb of doing welfare activities for their

employees whereas on the other hand, it is like a castigation for those Companies who

are using the Trust Route with bona fide intent to reward Employees and are

continuously working towards creating real wealth for their real jewels i.e. Employees.

Disclaimer:

The entire contents of this document have been developed on the basis of relevant statutory provisions and the

information available at the time of the preparation. Though the author has made utmost efforts to provide authentic

information however, assumes no responsibility for any errors which despite all precautions, may be found herein.

The material contained in this document does not constitute/substitute professional advice that may be required

before acting on any matter. The author and the company expressly disclaim all and any liability to any person who

has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be

done by any such person in reliance upon the contents of this document.