Decoding Insider Trading Regulations around ESOPs

Introduction:

Understanding the regulatory framework under the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”) regarding employee stock options (“ESOPs”) is crucial for companies, employees, and professionals. The Securities and Exchange Board of India (“SEBI”) has established stringent guidelines to curb insider trading and ensure fair market practices. This blog aims to decode the PIT Regulations around ESOPs.

For a transaction to fall under the PIT Regulations, it must be carried out by an insider and amount to trading. While ESOPs are defined as securities, their basic features non-transferability and non-tradability on stock exchanges necessitate a closer look at whether the Regulator’s intention is to govern the transaction of ESOPs or the shares arising from the exercise of ESOPs (“ESOP Shares”).

Assuming the option grantee is an insider, the real analysis is whether any stage of ESOPs is considered as trading.

Stages of ESOPs & Applicability:

1. Grant: The grant of ESOPs does not fall under the definition of trading. SEBI’s FAQs clarify that the PIT Regulations do not apply at the time of grant. (Ref SEBI FAQ No. 30).

2. Vesting: Employees meet conditions to earn the right to exercise ESOPs in this stage, therefore vesting does not fall under the definition of trading, hence PIT Regulations is not applicable.

3. Exercise: Conversion of ESOPs into ESOP Shares by way of payment of exercise price and taxes is termed as exercise. Though the insider is acquiring the shares by exercising ESOPs, the PIT Regulations is not applicable as the exercise of ESOPs does not amount to trading as per the exception given in Regulation 4(1)(iv) of PIT Regulations.

4. Sale: Selling of the ESOP Shares amounts to trading, hence the PIT Regulations are applicable, same has also clarified by the SEBI in FAQs. (Ref SEBI FAQ No 36).

Given the above analysis of ESOPs stages, we can say that the PIT Regulations is not applicable to ESOPs, but it is applicable to ESOP Shares and at the stage of sell of ESOP Shares.

We can now analyze the key provisions of PIT Regulations applicable while dealing with ESOP Shares.

Contra-trade Restrictions:

Insider is prohibited from conducting an opposite transaction of buying or selling from the last trade in the company’s shares for a period of six months. However, the shares acquired through exercise of ESOPs are not considered as buy transaction for the contra-trade restrictions. Therefore, only the sell of ESOP Shares is significant when ascertaining if a transaction is a contra-trade.

Trading Window

1. Insider cannot execute any trade during the trading window closure period as intimated by the Compliance Officer from time to time. These restrictions apply to the sell of ESOP Shares as well.

2. In case of sell of ESOP Shares is carried out as per the approved Trading Plan, the restrictions of Trading Window norms are not applicable as per Regulation 5(3) of PIT Regulations.

Pre-clearance:

1. Insider must get approval from the Compliance Officer for transactions exceeding a specified threshold limit as mentioned in the company’s code of conduct. Therefore, in the event of sell of ESOP Shares exceeding the threshold limit set by the company, the insider needs to obtain pre-clearance from the Compliance Officer.

2. Pre-clearance is also applicable to cashless exercise of vested options as both i.e. buy and sell transactions are carried out simultaneously. Further, only exercising of ESOPs is exempted from taking pre-clearance. (Ref SEBI FAQ No. 25 & 27).

3. In case, sell of ESOP Shares is carried out as per the approved Trading Plan, the requirement of pre-clearance is exempted as per Regulation 5(3) of PIT Regulations.

Disclosure Requirements:

1. Initial Disclosure: Form B, within 7 days of becoming an insider.

2. Continuous Disclosure: Form C or D for changes in securities holding, within 2 trading days.

Practical Approach:

We may observe that in any organization there are few employees who always deal with and possess UPSI, therefore, if such employees are also option holders, such insiders can adopt the following approach which will enable him/her to deal with ESOP Shares:

The terms and conditions of ESOPs are predefined (e.g., exercise price, exercise period) at the time of grant, insiders can check if any options are going to vest in the upcoming financial year and prepare and submit a Trading Plan to the Compliance Officer accordingly. With an approved Trading Plan, most key provisions of the PIT Regulations are exempted, allowing the insider to execute the trade. However, if a Trading Plan is not in place, all the compliances discussed above must be followed to carry out the sell of ESOP Shares.

Conclusion:

Navigating the PIT Regulations is crucial for both employers and employees involved with ESOPs. Understanding these regulations and implementing robust compliance practices can help mitigate risks and ensure that ESOPs serve their intended purpose of fostering employee ownership and motivation without compromising market integrity. By adhering to SEBI’s guidelines, companies and their employees can confidently participate in ESOPs while upholding ethical standards and regulatory requirements.

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