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Commentary

SEBI Bars ESOPs Buying Shares From Market

In a notification, SEBI has barred all public companies from having their ESOP trusts buy shares from the secondary market. ESOP trusts can only be allocated shares by the company directly (new shares).This applies to any new ESOP plans immediately, and existing ESOP trusts by Jun 30, 2012.

I had noted this in my post in August, from the SEBI Board Meeting minutes, that SEBI would bar such activity. Abuse by companies involve giving their ESOP trusts money to buy shares and thus manipulate prices in the market.

In the Network 18 case, the company effectively gave its assets as collateral so that the trust could buy shares in the market. It’s quite like borrowing money in order to buy its own shares, and the number of shares bought was MUCH more than the option pool size. This is nothing but abuse of the ESOP rules, which has now been plugged, with SEBI Saying:

It has come to the notice of SEBI that some listed entities have been framing their
own employees benefit schemes wherein Trusts have been set up to deal in their
own securities in the secondary market, which was not envisaged within the purview
of SEBI (ESOS and ESPS) Guidelines 1999.

It is apprehended that some entities may frame such schemes with the purpose of
dealing in its own securities with the object of inflating, depressing, maintaining or
causing fluctuation in the price of the securities
by engaging in fraudulent and unfair
trade practices. Such dealing in the company’s shares by the Trusts may also raise
regulatory concerns regarding compliance with SEBI (Prohibition of Fraudulent and
Unfair Trade Practices relating to the Securities Market) Regulations, 2003 and SEBI
(Prohibition of Insider Trading) Regulations, 1992.

(Emphasis mine)

In the Veritas-Indiabulls case, we noted that the Employee Welfare Trust (EWT) was given loans of Rs. 900 cr. at 12% p.a. by Indiabulls, in order to buy shares from the market. In that post, I’d noted a solution:

The only thing we can do to avoid this is to disallow ESOP trusts from buying shares directly from the market. They should only get fresh shares issues from the company at a certain price, and that also only on exercise.

It feels nice when the regulator has similar views!

Of course, this still doesn’t plug the odd case like CRISIL where the company’s buying back shares from the market while at the same time issue new shares to employees. However that can be addressed separately.

Meanwhile, all companies now need to report how many shares they have bought on which date, and at what price, since April 2012. It would be great if SEBI reveals such information to the public – that way we can see which company’s trusts might have "manipulated" shares. (And thus, avoid such companies post June 30!).

  • kkk says:

    I don’t understand some of the concerns. I understand that ESOPs are bad for investor but even a salary of employee is bad for investor. Given that a decision to grant ESOPs is taken, is it not good for investor that company buying back stock? I mean given a chance an employer and investor doesnt want to give any thing to employee but once granting ESOPs is taken, what is the problem in buying back those shares?
    I work for an MNC and we get RSUs every year and almost every employee gets few shares. Admittedly a CEO might get millions of shares and we ordinary employees gets 100s but every body gets some and my company generally buys them back from market to keep the EPS on same levels and I always thought it is an accepted practice.

    • Well, it’s largely been abused. The company buyback is different from a trust structure purchase. The trust is an entity created by the company, which grants shares to employees. This is different from a regular ESOP where the company directly issues shares to employees. A trust is usually granted shares by the company, but in India it was also allowed to do market purchases. Too many companies have abused this clause – like L&T where the trust owns 12% of the company but not a single share has been granted to employees in the last five years. Or the other examples above.
      Instead, now trusts cannot buy from the market. The company can choose to do a buyback (there are rules for it). The buyback on RSU grant is not a good thing, according to me – it is far more efficient to just give cash to the employee, rather than use a complicated mechanism of RSU + buyback to achieve the same goal. However, that option still remains open to companies. Only, now trusts can’t be used to accumulate shares, because that doesn’t achieve the end goal of keeping EPS level at all (when a company buys back shares, they are extinguished. When a trust buys them, they remain in issuance)

  • Shiva says:

    Can I jump the gun and say in typical market parlance that the current SEBI board is exceeding expectations!! Barring ESOPs interferences, launching no expenses DIRECT funds, cutting down number of MF schemes, barring random new MF launches, etc..

  • RANDHIR says:

    If the SEBI circular is read in strict sense, it seems the intent of SEBI is to bar all trust framed for employee benefits/welfare from dealing in the securities of the company in the secondary market. That means not only the trust framed for ESOP/ESPS but other Employees Welfare trust such as trust for employees loans etc are also prohibited from dealing in the securities of the company in secondary market.
    Please share your view on this.