SEBI informal guidance – ESOP, Insider Trading and independent directors

The SEBI recently issued an informal guidance note on matters relevant to companies which are in the process of devising employee share option plans (ESOPs).

A company contemplating an ESOP in accordance with the SEBI (ESOP and ESPS) Guidelines, 1999 wished to form an employee welfare trust to grant options to eligible employees and desired to appoint its Independent Directors as trustees of the trust. Further, it also wished to grant options to those directors.

In its note, the SEBI stated, “… the following persons are not eligible to participate in the ESOS: (a) an employee who is the promoter or belongs to the promoter group; (b) a director who either by himself or through his relative or any body corporate, directly or indirectly holds more than 10% of the outstanding equity shares of the company. Thus it is clear that the company is not specifically prohibited from allocating options to the Independent directors of the issuing company who are acting as Trustees of the Trust.

In the same note, the SEBI also answered a connected question related to the SEBI (Prohibition of Insider Trading) Regulations, 1992. Under the Regulations, independent non-executive directors are individually included within the definition of the term ‘insiders’. The question then arose as to whether the independent directors acting as trustees would be “dealing in securities” for the purposes of the Regulations even when they were acting in their capacity as trustees and not in their individual capacities.

On this issue, the SEBI reasoned that under company law, shares cannot be held by a trust in its own name. It can be inferred from Section 153 of the Companies Act that shares of a trust would necessarily have to be held in the name of one or more trustees. Further, “… independent non-executive directors are insiders… Regulation 3(i) will be applicable to them in their individual capacity as well as trustees.”

The SEBI then concludes, “Therefore, to prevent any possible misuse of trust and to ensure transparency in operations, independent non-executive directors should make proper disclosures as per the Regulations whether they hold the shares in their individual name or in the name of the trust.

The note is available here.

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Mihir Naniwadekar

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