Request for interpretive/No action letter on SEBI (ESOP Scheme and ESPS scheme) guidelines 1999

Guidance/Interpretation under the SEBI (Informal Guidance) Scheme, 2003"

 

September 17, 2003

 

Ms Neelam Bharadwaj,

General Manager,

Securities & Exchange Board of India,

Mumbai.

 

Madam,

 

Sub : Application under SEBI (Informal Guidance Scheme), 2003 regarding Esops and related issues.

 

Please refer discussion regarding regulations applicable for Esops. We seek SEBI’s clarifications by way of ‘interpretative letter’ or ‘no action’ letter for the following issues under SEBI (Informal Guidance Scheme), 2003.

 

 
1. Inclusion of Restricted Stock award under ESPS- Preferential allotment guidelines not to apply (No action).

  

1. Scheme of Restricted stock awards- This concept is getting popular in US and it involves issue of shares to employees which vest over a period of time.

1.  
   1.  
      1. The scheme involves issue of share upfront as against grant of options which on exercise result in allotment of shares at a later date.

       

      2. These shares will have a ‘lock in’ restriction for a pre determined period of time/ condition. After completion of the said period/ lapse of the condition, the shares vest unconditionally in the employee and are freely tradable.

       

      3. Shares are issued at a discount to the market price and close to the nominal value. Employees pay the subscription amount upfront for allotment of these shares.

       

      4. In case of separation of the employee while the restrictions continue, the shares will be transferred to a Employee Welfare Trust settled by the company for the purpose.

       

      5. The shares with the trust will again be reissued in the same manner as the original issue of shares by way of restricted stock awards by the company.

       

 

Regulatory issues : Regulatory issues are mentioned below in brief.

1.  

    

   1. ‘Employees Stock Purchase Scheme’ (ESPS) entails issue of shares as a part of a public issue or otherwise [clause 2.1(4) of the SEBI (Employee stock options scheme) guidelines, 1999]. The words ‘Or otherwise’ as per clause 2.1(4) of these Esop guidelines could mean a preferential allotment. Hence issue of shares made to employees by way of preferential allotment under the Esop scheme could be construed to be covered by the esop guidelines.

    

   2. As per clause 1.2.1 (xxii), preferential allotment means an issue of capital made by a body corporate in pursuance of a resolution passed under sub-section (1A) of Section 81 of the Companies Act, 1956.

    

   3. Section 81(1A) covers issue of shares to persons other than the existing shareholders and hence a preferential allotment to employees as per ESPS could be construed as preferential allotment.

    

   4. As a result issue of shares through the preferential route to employees under ESPS scheme could require compliance with the Guidelines for preferential Issues as per chapter XIII of the SEBI (Disclosure and Investor Protection) Guidelines, 2000.

    

   5. As per clause 20.1 of the Esop Guidelines, these Esop guidelines will not be applicable to issue of shares made to employees in compliance with the SEBI guidelines on preferential allotment.
      
      
       
   6. Clause 20.1 leads to an interpretation that issue of shares made to employees on a preferential basis is not governed by these Esop guidelines and are governed by the guidelines on preferential issue of such shares.

    

   7. As per Clause 18.2 of the guidelines shares issued under ESPS are subject to minimum lock in period of one year from the date of allotment. This restricts the company from issuing shares under the scheme to employees with less than one year lock in cases of acquisition of companies.

    

 
2. No action letter required :

 

i. We request that a ‘No Action’ letter be issued for our plan to go ahead with the issue of Restricted Stock awards under a new ‘ESPS scheme’ through the preferential allotment route such that the preferential issue guidelines shall not be applicable to such issue of shares and only Esop guidelines shall be applicable for such issue.

 

ii. We also request ‘No Action’ letter for our plan to go ahead with the issue of restricted stock awards under ‘ESPS scheme’ with less than one year lock-in in cases of acquisitions/ merger transactions etc.

 

iii. We also request ‘No Action’ letter for our proposal to amend the existing Employees Stock option Schemes of the company to an ‘ESPS scheme’ to enable us to grant Restricted Stock Awards under the schemes as amended and to treat the issue of such restricted stock awards as if the same was granted under the original scheme under the SEBI (Employee stock options scheme) guidelines, 1999 and that Esop preferential issue guidelines shall not be applicable for such issues.

 

 

2. Administration of the Employees Restricted Stock Award scheme through the Trust route (No- action letters).

Esop Trust is proposed to be formed for the purpose which will carry out the following functions :

 

• Purchase of shares issued under ESPS from employees before completion of the vesting period.

 

• Reissue of the shares purchased by the ESPS trust

 

 No action letter required :

 

1. Kindly confirm by way of ‘No action letter’ if the above scheme of things are covered by the Esop guidelines in terms of clause 22A and other provisions of the guidelines.

 

2. We also request ‘No Action’ letter for our proposal to amend the existing Employees Stock option Schemes of the company to an ‘ESPS scheme’ administered through the trust route to enable us to grant Restricted Stock Awards under the schemes as amended and to treat the issue of such restricted stock awards and administration through the trust route as if the same was granted under the original scheme under the SEBI (Employee stock options scheme) guidelines, 1999.

 

 

3. Transferability of options (Interpretative letters)

 

 

As per clause 11.1 options issued to employees are not transferable to any other person. This results in difficulties in the cash less exercise of the options. The optionees have to presently apply and pay for the shares and only later transfer these shares. We request you to consider allowing the transferability of stock options in case of cash less exercise of options so that the employees get the benefit of the same.

 

Interpretative letters required :

 

1. Kindly confirm whether as an exception stock options issued to employees under SEBI (ESOP scheme and ESPS scheme) Guidelines, 1999 can be transferred to another person in case of cash less exercise of those options. Also please confirm if the underwater options (options whose exercise price is more than the market price) can also be covered under the cash less exercise of options.

 

2. We also request ‘Interpretative’ letter for our proposal to amend the existing Employees Stock option Schemes of the company to permit transfer of options under the schemes as amended and to treat the transfer as if the same was permitted under the original scheme under the SEBI (Employee stock options scheme) guidelines, 1999.
    
   1. Issue of stock options and Stock awards to non employees

 

 

As per clause 4.1 to 4.3 only employees, directors (other than promoter directors) are eligible to participate in the ESOP and ESPS schemes.

Due to the outsourcing nature of work in vogue both in India and abroad, it is increasingly becoming common practice abroad to cover stakeholders like consultants, employees whose nature of employment is contractual under the Esops schemes applicable to employees.

 

In the US and other developed countries, companies are free to issue options to their business associates, customers and suppliers. This enables companies to build better relationship with their business associates, customers and suppliers. Inability of Indian Companies to grant options, particularly to customers results in the Indian Company not being eligible for a level playing field. This often results in Indian companies being handicapped as compared to its competitors from overseas when making a pitch for business prospective customers.

 

A clarification to the effect that shares issued under the scheme to non employees like business associates, customers, suppliers and persons who are not directors be treated at par with that of shares issued to employees and non promoter director will help in getting and retaining the right talent whether on employment basis or otherwise.

 

 

Interpretative letters required :

 

1. Kindly confirm whether shares issued to non employees like consultants, contractual employees etc will be covered under the purview of SEBI (ESOP scheme and ESPS scheme) Guidelines, 1999.

 

2. We also request ‘Interpretative’ letter for our proposal to amend the existing Employees Stock option Schemes of the company to enable us to grant Stock options to non employees like consultants, contractual employees etc under the schemes as amended and to treat the issue of such stock options as if the same was granted under the original scheme under the SEBI (Employee stock options scheme) guidelines, 1999.

 

1.  
    
   1. Relaxation of minimum vesting period of 1 year.

    

 

As per clause 9.1 of the guidelines, there shall be a minimum period of one year between the date of grant of options and vesting of options. This restricts the company from issuing stock options with vesting periods of less than one year as explained herein below.

 Mergers and acquisitions:

 

In the context of an assumption/substitution of Options when a company makes an acquisition and consequently assumes/substitutes options such assumption/substitution of Options always implies that the same terms and conditions including the same vesting schedule for the Options are contractually maintained. In the event that the companies are required to maintain a one-year lock-in, it would be impossible for the Company as the Options of the Target would in some cases have already fully vested in the employee or would be vesting within a certain period of time post acquisition (which may be less than 12 months) and they would be unwilling to comply with the additional one year lock-in period. In other words, the employees of the Target would insist upon maintaining the same Vesting Schedule as was applicable to the Options issued by the Target prior to acquisition.

 

Incidentally, unlike the SEBI ESOP Guidelines, the regulations pertaining to ESOP as existing in USA, UK etc do not provide for a lock in period of one year between the date of the grant of the option and the vesting of the option.

 

No action letter required :

 

1. Kindly confirm by way of ‘No action letter’ if an exemption from complying with the minimum vesting period of one year as stipulated in the existing ESOP guidelines issued by the SEBI can be granted so as to enable the Indian listed Companies to issue options in acquisition transactions in India and overseas without having to maintain a minimum vesting period of one year from the date of grant. 

 

 
2. We also request ‘No Action’ letter for our proposal to amend the existing Employees Stock option Schemes of the company to enable Indian listed Companies to issue options in acquisition transactions in India and overseas without having to maintain a minimum vesting period of one year from the date of grant under the schemes as amended and to treat the issue of such options with reduced vesting period as if the same was granted under the original scheme under the SEBI (Employee stock options scheme) guidelines, 1999.

 

Please issue us guidance by way of ‘No Action’ letters or ‘Interpretative letters’ as requested in the above paragraphs for the five issues highlighted above. The application fee is enclosed herewith by way of Demand draft no. 024800 dated September 8, 2003 drawn on State Bank of India, Mumbai for Rs 25,000.

 

Kindly treat this letter as confidential for a period of 90 days in terms of clause 11.a of the SEBI (Informal guidance) scheme, 2003 as we are in the process of implementing some of these issues in our Esop/ ESPS/ Stock award schemes which are price sensitive in nature.

 

Thanking You,

 

Yours Faithfully,

For Wipro Limited

 

V. Ramachandran

Company Secretary

 

Encl : a/a

 

REPLY

 

"Disclaimer:

The letter issued by a Department of SEBI constitutes the views of the Department in respect of the particular case and under the facts and circumstances of the particular case and cannot be applied in general. The views expressed therein are not binding on the Board and shall not be construed as a conclusive decision or determination of any question of law or fact by SEBI. Such a letter cannot be construed as an Order made by the Board"

 

 

Deputy General Manager

Corporation Finance Department

Division of Issues and Listing

 

( (Board) : 22850451- 56 , 22880962 - 70 (Extn. : 367)

Fax : 22045633

 

Email :  neelamb@sebi.gov.in 

CFD/DIL/UR/ /2003

December 16, 2003

 

Wipro Limited

Doddakannelli

Sarjapur Road

Bangalore 560 035

 

Kind Attn.: Mr.V.Ramachandran, Company Secretary

 

Dear Sir,

 

Reg.: Application under SEBI (Informal Guidance Scheme) 2003

 

October 31, 2003

 

Ms Usha Rangarajan,

Securities & Exchange Board of India,

Mittal Court, ‘B’ Wing,

First Floor, 224, Nariman Point,

Mumbai : 400 021.

 

Madam,

 

 

Sub : Reply to your queries regarding our application under SEBI (Informal Guidance Scheme), 2003 regarding Esops and related issues.

 

Please refer discussion regarding regulations applicable for Esops. We furnish our replies to your letter no. CFD/DIL/UR/ 2027 dated Oct 27, 2003 and seek SEBI’s clarifications by way of ‘interpretative letter’ or ‘no action’ letter for the following issues under SEBI (Informal Guidance Scheme), 2003. 

1.  
   1. Your query : Please clarify whether shares under ESPS Scheme are proposed to be offered under SEBI (ESOP& ESPS) Guidelines, 1999 or in terms of the SEBI (DIP) Guidelines on Preferential Allotment.

    

Our replies : The shares under ESPS scheme is proposed to be offered under SEBI (ESOP & ESPS) Guidelines, 1999 and not  under SEBI (DIP) Guidelines on preferential allotment.

 

 
1. Your query : You have sought our No Action/ Interpretative Letters to your proposal to amend the existing ESOP scheme.

 

• to an ESPS Scheme administered through Trust route (to enable them to grant restricted stock awards under the Schemes as amended)

 

• To treat the issue of such restricted stock awards as if the same was granted under the original scheme under SEBI (ESOP) Guidelines, 1999

 

• To permit transfer of options Please elaborate on the same giving specific details of the proposed amendments to the existing ESOP scheme, effect thereof on the options already granted, whether the amendments enabling grant of restricted stock awards would be applicable prospectively, whether the interests of the employees covered under the existing ESOP scheme are protected etc.

 

Our replies : The proposed amendments have yet to be worked out for each of the ESOP Plans but would involve amendments to change the existing options scheme to an ESPS scheme and to be administered through the trust route. The effect thereof to the options already granted would be made in such a manner that the employee’s interests will be protected.

The amendments could be made effective from a date as may be decided by the compensation committee and as approved by the shareholders of the company and the interests of the employees covered under the existing scheme will be protected.

 

 
1. Your query : As regards no action letter to enable issue of options in acquisition transaction in India and overseas without having to maintain a minimum vesting period of one year, please elaborate giving specific details.

 

 

Our replies : Our replies are given below.

 

Merger and acquisition transaction : Normally the Target company (The company being acquired) in the course of its operations, would have already issued ESOPs to its employees prior to the acquisition transaction at various points in time. In the context of an acquisition of a Target, the ESOPs could be categorized as under;

 

1. Options which have already been vested but not exercised by the employees of the Target company at the time of acquisition.

 

2. Options which would be vesting anywhere between zero and twelve months from the date of the acquisition.

 

In an acquisition of the Target company by an Acquirer, it is the general practice for all Options issued by the Target company to be assumed or substituted by the Acquirer company by grant of fresh Options of the Acquirer company to those optionees. Identical vesting schedule would be required under contractual obligation between the Target Company and its employees. Such a Vesting Schedule could be anywhere between zero to twelve months or more from the date of the acquisition.

 

SEBI ESOP/ ESPS Guidelines inter alia provide that there should at least be one year period between the grant of options and vesting of the option.

 Issue

 

 

This scenario is proving to be problematic particularly in the context of an assumption/substitution of Options when a company makes an acquisition and consequently assumes/substitutes options. This is because assumption/substitution of Options always implies that the same terms and conditions including the same vesting schedule for the Options are contractually maintained. In the event that the companies are required to maintain a one-year lock-in, it would be impossible for the Company as the Options of the Target would in some cases have already fully vested in the employee or would be vesting within a certain period of time post acquisition (which may be less than 12 months) and they would be unwilling to comply with the additional one year lock-in period. In other words, the employees of the Target company would insist upon maintaining the same Vesting Schedule as was applicable to the Options issued by the Target company prior to acquisition.

 

Incidentally, unlike the SEBI ESOP Guidelines, the regulations pertaining to ESOP as existing in USA, UK etc do not provide for a lock in period of one year between the date of the grant of the option and the vesting of the option.

 

Approval required

In the light of the above difficulties faced by the Indian listed companies while pursuing and implementing acquisition transactions, may we kindly request for a specific exemption from complying with the minimum vesting period of one year as stipulated in the existing ESOP/ ESPS guidelines issued by the SEBI so as to enable the Indian listed Companies to issue options/ ESPS in acquisition transactions in India and overseas without having to maintain a minimum vesting period of one year from the date of grant and to maintain the same vesting schedule as was applicable to the options issued by the target company prior to such acquisition.

 

4. Your queries : As regards transferability of options, please furnish specific details regarding the issue of transfer of options in case of cash less exercise (and under water options) and the rationale therefor.

 Our replies : As per clause 11.1 of the Esop guidelines, options are not transferable. As a result employees whose stock options are vested cannot sell the same immediately and have to go through the following process:

 

a. Exercise the vested options

b. Get the shares allotted pursuant to the exercise of options.

c. Get the shares credited in the demat account post allotment.

d. Give instructions to sell the shares in a stock exchange through the broker.

e. Delivery instructions through the DP for sale of demat shares

f. Realising the money from the broker.

 

The above process takes anywhere between 20 to 30 days. The current process also does not lead to a cash less exercise as the optionee has to pay for the shares and then get sale consideration.

 

Our request is to consider transferability of options quite similar to that of transferability of rights entitlement in a rights issue. For example, in a rights issue, the shareholder gets an entitlement to apply for that company’s shares. Depending on the market price of the shares, the rights entitlement could fetch a price and is tradable in the stock exchange. For example, if the price of a share in the market is Rs 100 and the issue price for the rights issue is say Rs 60, then the shareholders can sell the rights at a price of Rs 40 (subject to deductions for brokerage, interest etc). There is no requirement for the shareholder to first subscribe to the rights shares at Rs 60 and then sell the shares at Rs 100 on a later date. Similarly, in case of stock options the option holder should be allowed to sell the options so that the optionee gets the difference in price without investing cash upfront, also called ‘cash less exercise’.

 

Underwater options are stock options whose exercise price is more than the prevailing market price. As a result the option holder will not have any gain from exercising the shares. We were also seeking your approval for transfer of those underwater options by the option holder.

 

5. Other issues : Kindly also refer our letter dated September 17, 2003 regarding the issue of stock options/ ESPS to non employees like business associates, consultants, advisors etc. In US and other developed countries, stock options are offered to such categories of non employees also.

 

Currently, IT companies are at a disadvantage vis a vis the companies located abroad as the later companies are able to offer such options to non employees and are hence able to get the required talent. This is felt as a handicap for Indian companies both in the case of retaining such non employees in a merger and acquisition transaction as well as for hiring employees abroad as such employees are being offered Esops by our competitiors. Kindly consider this issue also as explained in our letter of September 17, 2003 item no 4.

 

Kindly take the above submissions on record and accord the required approvals by way of No action letter/ interpretative letters.

 

Thanking You,

 

Yours Faithfully,

For Wipro Limited

V. Ramachandran

Company Secretary

We refer to your letter dated September 17, 2003 and email dated November 5, 2003 seeking no action letter / interpretative letter under SEBI (Informal Guidance) Scheme 2003.

Without necessarily agreeing to your analysis, we clarify as under :

 

1. The company has to comply with either Chapter XIII of the SEBI (DIP) Guidelines, 2000 on preferential allotment or with the SEBI (ESOS & ESPS) Guidelines, 1999 in respect of issues made to employees.

 

2. The administration of ESOP/ESPS Scheme through Trust route is permissible under SEBI Guidelines subject to compliance with other applicable laws, if any.

 

3. As regards, transferability of options, you are advised that per Clause 11.1 of SEBI (ESOS & ESPS) Guidelines, option granted to an employee shall not be transferable to any person. The special provision regarding cashless exercise of options found in clause 11.2(b) also does not make any exception in this behalf. In case of cashless exercise of options also, the exercise and authorization to sell have to be made by the employee-option holder. The restrictions also apply to underwater options. It may also be noted that cashless exercise is generally not permissible in respect of options allotted to directors, officers or designated employees in view of the minimum holding period given in clause 4.2 in Part A of Schedule I (Model Code of Conduct) of the SEBI (Prohibition of Insider Trading) Regulations, 1992.

 

4. The provisions of the SEBI (ESOP & ESPS) Guidelines, 1999 apply only in respect of options granted or shares offered to employees, as defined in Clause 2.1(1) of the said guidelines. As such, it is clarified that no options/shares can be issued to non employees in terms any ESOP/ESPS Scheme under the purview of SEBI (ESOP & ESPS) Guidelines and any such issue would attract the guidelines relating to preferential allotment or regulations in respect of sweat equity and/or other requirements, as may be applicable.

 

5. Your request for relaxation of minimum vesting period of one year in case of a merger or amalgamation has been examined and you are advised that in terms of Clause 9.1 of SEBI (ESOP & ESPS) Guidelines, there shall be a minimum period of one year between the grant of options and vesting of options. Further, as per Clause 18.2, shares issued under an ESPS Scheme shall be locked in for a minimum period of one year from the date of allotment.

 

6. As regards No Action / Interpretative Letters to your proposal to amend the existing ESOP /ESPS Scheme, you are advised that the amended scheme should be in accordance with the Guidelines. Since the original ESOS/ESPS scheme would have been approved by shareholders under section 81(1A) of the Companies Act, any amendment thereto can be made after making complete disclosures to the shareholders and with their approval.

 

This position is based on the representation made to the Division in your letter. Different facts or conditions might require a different result. This letter expresses the Division’s position on enforcement action only. It does not express decision of the Board on the questions presented.

 

Yours faithfully,

 

NEELAM BHARDWAJ