Submission highlighting issues faced by the Industry in relation to cashless exercise of employee stock options granted by listed entities

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Submission highlighting issues faced by the Industry in relation to cashless exercise of employee stock options granted by listed entities

Tejasvi

@tejasvi

September 19, 2022

Public Policy

162

Employee stock options are increasingly being used as a tool to incentivise and retain talent by a company. Generally, there are two types of cashless settlement mechanism for stock options:

a) Sell-to-Cover Mechanism: In this option, certain number of shares (to be acquired on exercise) are sold to cover the exercise price and taxes, and remaining shares are transferred to the employee; and

b) Sell-all Mechanism: In this option, employee stock options are settled by way of net cash payment to the employee after options are exercised and all the acquired shares are sold on behalf of the employee.

The Companies Act, 2013, which regulates grant of options by private and unlisted public companies, does not contain any specific provision on companies undertaking cashless exercise. However, the Securities and Exchange Board of India (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (SBEB 2021 Regulations) provide for cashless exercise of options granted by listed entities. SBEB 2021 Regulations have replaced the erstwhile SEBI (Share Based Employee Benefits) Regulations, 2014 (SBEB 2014 Regulations).

SBEB 2021 Regulations

Regulation 3(15) of SBEB 2021 Regulations provides that the trust through which an Employee Stock Option Scheme (ESOS) is being implemented, is permitted to sell shares in secondary market to enable the option holder to fund the payment of the exercise price, the amount necessary to meet their tax obligations and other related expenses pursuant to exercise of options granted under the ESOS, i.e., Sell-to-Cover Mechanism only.

Further, Regulation 9(2) of SBEB 2021 Regulations provides that the company or the trustee may fund or permit empaneled stockbrokers to make suitable arrangements to fund the employee for payment of exercise price, the amount necessary to meet his/her tax obligations and other related expenses pursuant to exercise of options granted under the ESOS or SAR and such amount shall be adjusted against the sale proceeds of some or all the shares, i.e., Sell-All Mechanism.

Absence of similar provision under Regulation 3(15) is creating confusion among the Industry.

SBEB 2014 Regulations

As per SBEB 2014 Regulations, a trust could trade in shares and sell shares in secondary market for “cashless exercise of options under the scheme covered by Part A of Chapter III of the regulations” without any restrictions. Hence, it allowed cashless exercise of both Sell-to-Cover Mechanism and Sell-All Mechanism.

SEBI’s Report

SEBI’s Report on review of SEBI (Share Based Employee Benefit) Regulations, 2014 and SEBI (Issue of Sweat Equity) Regulations, 2002 (Report) released in July 2021 contemplated on the need to clarify the term ‘cashless exercise’. As per the Report, “the members of the Expert Group were of the view that since the term “cashless exercise” was not specifically defined under the SBEB Regulations, it would be helpful to include language to clarify the process pursuant to which cashless exercise may be undertaken under Regulations 3(15) and 9(2) of the SBEB Regulations.”

The Report consequently sets out the revised language for cashless exercise, providing that a trust can undertake cashless exercise of such number of shares as are required to pay the exercise price, and applicable tax obligations, etc. (i.e., Sell-to-Cover Mechanism). Pursuant to the Report, SBEB 2021 Regulations were introduced to replace SBEB 2014 Regulations taking the above into consideration.

We believe the intent of the Expert Group was not to restrict the cashless exercise only to Sell-to-Cover mechanism. This was clarified through an informal guidance issued by SEBI vide SEBI/HO/CFD/DCR1 /OW/P/2020/0011948/1 dated July 20, 2020 to Way To Wealth Brokers Pvt. Ltd.

In this regard, we have made a submission to SEBI to issue a clarification that under SBEB Regulations, cashless exercise of stock options through Sell-All and Sell-to-Cover mechanism are permitted. This will provide clarity to the option holders and facilitate ease of doing business in India.

For more information, kindly write to tejasvi@nasscom.in

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Tejasvi