SEBI Regulations Inapplicable to “Phantom” Stock Schemes

The SEBI (Share Based Employee
Benefits) Regulations, 2014 (the “Regulations”) regulate various types of
schemes offered by companies to their employees relating to shares. In two
separate letters issued pursuant to requests for informal guidance, SEBI has
stated that the Regulations are not applicable to phantom stock options and
similar schemes that do not involve the actual issue or transfer of shares to
employees. SEBI issued the informal guidance in response to requests from Mindtree
India Ltd
Mindtree’s request letter to SEBI
encapsulates the nature of a phantom stock option scheme where stock
appreciation rights (SAR) were issued to certain employees who also happened to
be promoters:
3. As per the
provisions of the Phantom Stock Option Scheme, only notional SAR units were
issued at a pre-determined grant price and the Promoters were entitled to
receive cash payment for appreciation in the share price over the grant price
for the awarded units, based on the Company achieving the specified revenue
targets. While the cash payouts pursuant to the Phantom Stock Scheme are linked
to the share price of the Company’s equity shares, implementation of the
Phantom Stock Scheme does not involve any actual purchase or sale of the equity
shares of the Company.
The issue arose because Regulation
1(3)(iii) of the Regulations provides that the Regulations apply to SAR schemes
in addition to other types of employee share benefit schemes. Furthermore, SAR
and related matters have been expressly dealt with in the Regulations. At the
same time, Regulation 1(4) states as follows:
The provisions of
these regulations shall apply to any company whose shares are listed on a
recognised stock exchange in India, and has a scheme:
(i)        for direct or indirect benefit of
employees; and
      involving dealing in or
subscribing to or purchasing securities of the company, directly or indirectly
(iii)      satisfying, directly or indirectly, any
one of the following conditions:
SEBI’s conclusion as to the
inapplicability of the Regulations to phantom stock schemes is based on the
highlighted portion above. This indicates the necessity for actual subscription
or purchase of shares by employees, which does not occur in the case of phantom
SEBI’s conclusion is understandable
and is likely to provide greater flexibility to companies to design their
employee share schemes as phantom schemes if they would like to stay outside
the purview of the Regulations. However, less clear is the apparent conflict
between Regulations 1(3), which expressly makes the Regulations to SAR and
Regulation 1(4), which requires subscription or purchase of shares by the
employees (which would never occur in a SAR). Moreover, it is not obvious as to
why there is a fairly extensive treatment on SAR in the Regulations if they are
not designed to cover these and similar phantom schemes in the first place.
Finally, due to the SEBI’s
conclusion that the Regulations do not apply to SARs, another interesting
question raised by Mindtree was found not to be relevant, which SEBI therefore
left unanswered. That question relates to the interpretation of Regulation
2(1)(f), which reads as follows:
f. “employee”
means, —
(i) a permanent
employee of the company who has been working in India or outside India; or
(ii) a director of
the company, whether a whole time director or not but excluding an independent
director; or
(iii) an employee as
defined in clauses (a) or (b) of a subsidiary, in India or outside India, or of
a holding company of the company or of an associate company but does not
(a) an employee who
is a promoter or a person belonging to the promoter group; or
(b) a director who
either himself or through his relative or through any body corporate, directly
or indirectly, holds more than ten percent of the outstanding equity shares of
the company;
Specifically, the question is whether
the exclusion of promoters and directors (holding substantial shares) applies
only to sub-section (iii) above, i.e. employees of subsidiary, holding company
or associate company or whether the exclusion applies to all categories of
employees, including those contained in sub-sections (i) and (ii). This
ambiguity may have to continue until it is clarified on a future 

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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