Cashless Employee Stock Option Scheme and Insider Trading Regulations

Last
year, the Securities and Exchange Board of India (“SEBI”) issued
a guidance note
clarifying certain matters regarding employee stock option
plans (ESOPs) and their implications under the SEBI (Prohibition of Insider
Trading) Regulations, 2015 (the “Insider Trading Regulations”). Specifically,
it stated that the “contra-trade” restrictions do not apply to the exercise of
stock options by employees and the sale of resultant shares by them within a
six-month period.
This
and related issues arose for consideration in an informal
guidance request
by KPIT Technologies Limited (“KPIT”). Apart from the
issues related to the aforesaid guidance note, specific concerns arose as KPIT
has established and implemented a cashless ESOP. Under this, the KPIT Employee
Welfare Trust (the “Trust”) was established to subscribe to or purchase shares
of the company. Each time an employee exercised an option, the Trust would sell
shares of the company and pay the employee the difference between the market
price of the shares and the exercise price of the options. The additional
question that arose in KPIT’s request was whether the Trust itself would be
subject to the contra-trade restrictions as it would be buying and selling
shares with a six-month period as part of its operations relating to the
implementation of KPIT’s ESOP. KPIT’s request stated that the Trust was
carrying out these functions not for itself, but for the benefit of the
employees, and hence whether the contra-trade restrictions in the Insider
Trading Regulations would apply to the activities of the Trust.
In
its informal
guidance letter
, SEBI provided favourable clarification on both counts,
which permits the implementation of a cashless exercise of stock options by
employees through the trust mechanism without violating the contra-trade
restrictions imposed by the Insider Trading Regulations. On the question of the
employees exercising the stock options, which results in a sale of the shares,
SEBI drew attention to the guidance note where it has provided an illustration
“that if a designated person has sold/purchased shares, he can subscribe and
exercise ESOPs at any time after such sale/purchase, without attracting contra
trading restrictions”. Similarly, the sale of shares after exercise of ESOPs
will also not attract the contra trading restrictions.
More
importantly, SEBI clarified the role of the Trust, in that it is not acting in
its own capacity by rather on behalf of the employees to give effect to the
exercise of ESOPs.[1]
Hence, its acquisition of shares and subsequent sale to give effect to the
exercise of the stock options by employees will not be considered a contra
trade.
In
all, through the guidance note and now the informal guidance issued to KPIT,
SEBI has been ironing out some of the practical issues that have arise in the
implementation of the Insider Trading Regulations.



[1]
Note: Technically, the Trust is not acting “on behalf of” the employees as it
is not in any agency capacity, but rather “for the benefit of” the employees
who are the beneficiaries. But, such a technical distinction should not alter
the outcome of the question pertaining to ESOPs and the Insider Trading
Regulations.

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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