To exercise ESOPs, staff of listed cos can pledge shares in trading window closures

The regulator’s guidance is expected to benefit employees whose ESOP (employee stock option plans) exercise windows often overlap with trading window closures imposed around the declaration of financial results.

Companies usually prohibit trading by designated persons during such periods under insider trading rules. This was creating difficulties for employees who depend on financing arrangements to exercise vested options.

In an informal guidance letter issued to Avenue Supermarts, which operates the DMart supermarket chain, the regulator said designated persons can create or revoke pledges on company shares to avail of loans from banks or financial institutions for exercising employee stock options, provided the transactions are bona fide and receive pre-clearance from the compliance officer.

“This informal guidance provides regulatory comfort and practical clarity on pledge-related transactions undertaken for legitimate purposes, especially in connection with stock option exercises,” said Shabnam Shaikh, Partner, Khaitan & Co. “While the informal guidance remains non-binding in nature, the clarification is reassuring from both a compliance and implementation perspective, for both companies and employees,” said Shaikh.

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Sebi said the determination of whether a transaction is bona fide would rest with the compliance officer of the company on a case-by-case basis under the firm’s code of conduct.
“Considering the ongoing IPO boom in India, and the increasing late-stage investments in pre-IPO and listed entities, ownership and share-linked incentives, and particularly employee stock options, are increasingly forming a significant component of employee compensation structures in India. Reflective of this trend, we are seeing that exercise prices are also no longer necessarily set at face value or deeply discounted values, and are now closer to prevailing fair market valuations, which has made the cost of exercising options and making the corresponding tax payments itself significant for employees,” Shaikh said. Sebi also said that the invocation of pledged shares by lenders would still attract contra-trade restrictions as it leads to a change in beneficial ownership and would be treated akin to a sale of shares.