This post analyses the scope of the regulatory framework governing employee benefits by equity listed companies in India and the applicability of the SEBI (Share-Based Employee Benefits and Sweat Equity) Regulations, 2021, to employee welfare trusts set up by promoters and share-linked but purely cash-based employee benefits.
Applicable regulatory framework
The Securities and Exchange Board of India Act, 1992, and its rules and regulations govern equity listed companies in India. To regulate employee share-based benefits, the Securities and Exchange Board of India (“SEBI”) has established regulatory frameworks from time to time, including the Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999, the SEBI (Share-Based Employee Benefit) Regulations, 2014 (“Erstwhile Regulations”), and the SEBI (Issue of Sweat Equity) Regulations, 2002, now replaced by the SEBI (Share-Based Employee Benefits and Sweat Equity) Regulations, 2021 (“SBEB&SE Regulations, 2021”).
The scope of the SBEB&SE Regulations, 2021, apparent from Regulation 1(4), expressly stipulates the applicability of these regulations any equity listed company that “seeks to issue sweat equity shares or has a scheme:- (i) for direct or indirect benefit of employees; (ii) involving dealing in or subscribing to or purchasing securities of the company, directly or indirectly; and (iii) satisfying, directly or indirectly, any one of the following conditions: – (a) the scheme is set up by the company or any other company in its group. (b) the scheme is funded or guaranteed by the company or any other company in its group. (c) the scheme is controlled or managed by the company or any other company in its group.”
Regulatory position on the ambit of ‘employee welfare trusts’ regulated by SEBI
Historical context on SEBI’s position on regulation of ‘employee welfare trusts’
SEBI first discussed the scope of trusts to be covered by a regulatory regime governing employee share-based benefits in the discussion paper on ‘Review of guidelines governing stock related employee benefit schemes’ released by the Primary Market Advisory Committee (“PMAC”) of SEBI on November 20, 2013 (“2013 Discussion Paper”). According to discussion point no. 1 of the Annexure of the 2013 Discussion Paper, the PMAC recommendation states. “The proposed regulations should cover all the schemes for the benefit of ‘employees’ which are set up, managed or financed by the company directly or indirectly through the mechanism of a Trust and which deal in actual securities of the company whether by way of purchase from/sale in the secondary market or grant of shares made by the company. The proposed regulations shall not be made applicable to Trusts/schemes which are not funded by the company or not having any outstanding loan to the company and also not under the control/management of the company.” It concluded that “trusts which are set up, managed or financed directly or indirectly by the company and which deal in actual securities of the company should be regulated.”
After releasing the Erstwhile Regulations and ahead of the SBEB&SE Regulations, 2021, the SEBI conducted another round of consultations in 2021 vide the discussion paper titled ‘Review of SEBI (Share-Based Employee Benefit) Regulations, 2014, and SEBI (Issue of Sweat Equity) Regulations, 2002’ dated July 8, 2021 (“2021 Discussion Paper”). Paragraph 2.3 of the 2021 Discussion Paper states, “The Expert Group discussed the issue and was of the view that the applicability criteria under Regulation 1(4) of the SBEB Regulations[1] are broadly drafted, so as to include the entire group of the listed company on the basis of funding, guarantee, control or management. During discussions, a scenario considered was if a promoter forms and funds a trust (which is not set up or funded or managed by the company nor impacts the profit and loss statement of the company), would it be covered under the SBEB Regulations? Members of the Expert Group were of the view that such scenario would be beyond the remit of the SBEB Regulations.”
Critiquing the ambiguity surrounding employee welfare trusts set up by promoters under the SBEB&SE Regulations, 2021
Regulation 3(1) of the SBEB&SE Regulations, 2021, stipulates, that “A company may implement a scheme(s) either directly or by setting up an irrevocable trust(s) …. Provided further that if the scheme(s) involves secondary acquisition or gift or both, then it shall be mandatory for the company to implement such scheme(s) through a trust(s)”. If the promoter establishes the trust, it cannot be said that the company set it up; however, the question remains whether a trust set up by the promoter would constitute as being “controlled or managed by the company or any other company in its group”.[2] A ‘promoter’ of a listed entity is defined as someone “who has control over the affairs of the issuer, directly or indirectly whether as a shareholder, director or otherwise” or “in accordance with whose advice, directions or instructions the board of directors of the issuer is accustomed to act.”[3] However, even in a scenario where an aforementioned promoter exercises direct or indirect control over the company or its group company, it would not lead to the company being able to exercise control or manage the trust. Consequently, pursuant to a strict interpretation of Regulations 1(4) and 3(1) shows that a trust set up by a promoter would not fall within the regulatory ambit of the SBEB&SE Regulations, 2021.
Regulatory position on share-linked but cash-based employee benefits
Historical context on SEBI’s regulatory position on purely cash-based employee benefits
Historically, ambiguity has been rife regarding SEBI’s regulatory position on share-linked and cash-based employee benefits such as phantom stocks and cash-settled stock appreciation rights.
SEBI first took a position on whether to regulate phantom stocks and purely cash-settled stock appreciation rights under the Erstwhile Regulations in its informal guidance to Saregama India Limited (“Saregama”) on July 24, 2015 (“Saregama Informal Guidance”)[4] and then to Mindtree Limited (“Mindtree”) on July 27, 2015 (“Mindtree Informal Guidance”)[5]. In the case of Saregama, phantom stock options were proposed to be granted, pursuant to which the optionees would have been entitled to the benefit of the increase in the price of the company’s equity shares from the date of grant to the date of exercise i.e., they would be entitled to the differential amount due to appreciation in the value of shares from the date of grant till the date of exercise. Similarly, in the case of Mindtree, pursuant to a phantom option scheme, only notional stock appreciation rights units were awarded at a pre-determined grant price, which entitled the optionees to receive cash payment for appreciation in the share price over the grant price for the awarded units. While the cash payout was linked to the share price, the implementation of the phantom stock option scheme did not involve the actual purchase or sale of equity shares. The primary question before SEBI in both cases was whether the Erstwhile Regulations would govern and thereby regulate these employee benefit schemes. Interestingly, in both the Mindtree Informal Guidance and the Saregama Informal Guidance, SEBI clarified that the pre-conditions for the applicability of the Erstwhile Regulations was that the said employee benefit scheme should actually involve “dealing in or subscribing to or purchasing securities of the company directly or indirectly”. Consequently, it held that the Erstwhile Regulations would not regulate these schemes.
This specific question was also discussed by the ‘Expert Group on the Securities and Exchange Board of India (Share-Based Employee Benefits) Regulations, 2014 and the Securities and Exchange Board of India (Issue of Sweat Equity) Regulations, 2002’ (“Expert Group”), constituted by SEBI to identify practical issues involvingthe Erstwhile Regulations, among other things. The Expert Group shared its recommendations with SEBI on June 18, 2021, reiterating SEBI’s position in the informal guidances issued to Saregama and Mindtree and clarifying that no regulatory change to Regulation 1(3) of the Erstwhile Regulations was required.
Thus, the position under the Erstwhile Regulations was that any employee benefit scheme which entitles the optionee to a cash consideration linked to the value of securities of the company without involving dealing in or issuance or sale of securities would not be regulated.
Understanding SEBI’s extant position
The operative parts of Regulation 1 of the SBEB&SE Regulations, 2021, have the same language as that in the Erstwhile Regulations; and hence, there is nothing to indicate any change in SEBI’s position under the Erstwhile Regulations.
Moreover, soon after the release of the SBEB&SE Regulations, 2021, on August 13, 3021, SEBI also issued certain Frequently Asked Questions dated November 16, 2021 (“SEBI FAQs”), specifically clarifying the applicability of SBEB&SE Regulations, 2021, to phantom stock options, as follows: ““Phantom stock options” are a form of share-based employee benefits based on the underlying value of equity shares of the employer company. The settlement of such options is made in cash and not in equity shares of the company. Since phantom stock options do not involve any actual purchase or sale of the equity shares of a listed company, the same would not be covered under the SBEB and SE Regulations, 2021.”
The SEBI recently constituted an ‘Expert Committee for facilitating ease of doing business and harmonization of the provisions of ICDR and LODR Regulations’ (the “Expert Committee”) on August 24, 2023, under the chairmanship of Shri S. K. Mohanty. The Expert Committee conducted a review of regulations applicable to listed companies including, among other things, theSBEB&SE Regulations, 2021. They recently submitted their final recommendations to SEBI, including recommendations around the inclusion of stock appreciation rights (“SARs”) under the proviso of Regulation 5(2) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR”). SEBI’s view holds that only an ESOP scheme would be covered under Regulation 5(2) of the ICDR, because of the absence of any express enabling provision to allow share-settled employee benefits other than ESOPs to be issued by equity unlisted companies. However, it is pertinent to note here that while phantom stocks are a special kind of SARs, the Expert Committee’s recommendation do not reflect a change in SEBIs position on phantom stocks. The SBEB&SE Regulations, 2021, and the Expert Committee recommendations only indicate a need to regulate SARs due to the option that they carry for their conversion (upon exercise) to the company’s equity shares and the consequent impact they have on the company’s share capital table. Phantom stocks are SARs that do not carry the option for exercise into the company’s equity shares and can only be cash settled. This automatically excludes them from the regulatory net of the SBEB&SE Regulations, 2021, which regulate SARs carrying an option of being settled by a cash payment or by the company’s shares.[6]
Conclusion
The SBEB&SE Regulations, 2021, established a robust regulatory and compliance framework for listed companies offering share-based employee benefits. It is pertinent for listed companies to appropriately consider whether the various incentive structures fall within the ambit of the SBEB&SE Regulations, 2021.
For further information, please contact:
Bharath Reddy, Partner, Cyril Amarchand Mangaldas
bharath.reddy@cyrilshroff.com
[1] Note that the wording of Regulation 1(4) of the Erstwhile Regulations is similar to the wording of Regulation 1(4) of the SBEB&SE Regulations, 2021.
[2] Regulation 1(4)(iii)(c) of the SBEB&SE Regulations, 2021.
[3] Regulation 2(1)(oo) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.
[4] SBEI’s informal guidance to Saregama is accessible here SEBI | In the matter of Saregama India Limited regarding SEBI (Share Based Employee Benefits) Regulations, 2014
[5] SBEI’s informal guidance to Mindtree is accessible here SEBI | In the matter of Mindtree Limited regarding SEBI (Share Based Employee Benefits) Regulations, 2014
[6] Regulation 2(qq) of the SBEB&SE Regulations, 2021 define SARs as “a right given to a SAR grantee entitling him to receive appreciation for a specified number of shares of the company where the settlement of such appreciation may be made by way of cash payment or shares of the company. Explanation 1,—A SAR settled by way of shares of the company shall be referred to as equity settled SAR. Explanation 2,—For the purpose of these regulations, any reference to stock appreciation right or SAR shall mean equity settled SARs and does not include any scheme which does not, directly or indirectly, involve dealing in or subscribing to or purchasing, securities of the company”.
