Wednesday, August 6, 2008

Stock Options for Nominee Directors

Nominee directors on Indian corporate boards are a unique category of directors. They are usually are nominated by a bank, financial institution or other large investor to be a director on companies in which such nominating entities have invested. Sometimes, nominee directors also find themselves in an unenviable position – in case of a conflict between the interests of the nominating institution and the company, whose interests are they required to protect? Although there is no definitive guidance on this aspect of the law, one thing is fairly clear. All directors (whether nominated or otherwise) owe fiduciary duties to the companies on whose boards they sit. Such duties are non-derogable and, to that extent, in case of a real conflict, a nominee director may be required to put the interests of the company before the interests of the nominating entity.

Nominee directors need to be paid for their services, as in the case of other directors. Often, certain institutions follow the practice where nominee directors are required to turn their fees received from companies over to the nominating entities as they are only on those boards at the will of these nominators. This arrangement would not truly reflect the return for the personal services (such as advisory and monitoring role performed) of these directors.

As regards the availability of stock options as a form of remunerating their services, the position was somewhat unclear. This has been put to rest by a circular issued by SEBI this week amending the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999. The changes introduced are briefly described in the circular as follows:

“(a) Presently, as per SEBI (ESOS & ESPS) Guidelines, an employee (including a director of a company / its holding company / its subsidiary, whether such director is a whole-time director or not) is eligible to participate in the ESOS of the company, if such employee is not a promoter, does not belong to the promoter group and is not a director, who, either by himself or through his relative or through any body corporate, directly or indirectly holds more than 10% of the outstanding equity shares of the company.

(b) It has been decided to clarify that a director, nominated by an institution as its representative on the Board of Directors of a company, is eligible to participate in the ESOS of the company, if the contract / agreement entered into between the nominating institution and the director so appointed specifically provides for acceptance of ESOS of the company by such director and a copy thereof is filed with the company.”
An important aspect of this amendment is that the “options granted to a director, who is an employee of an institution and has been nominated by the said institution, shall not be renounced in favour of the institution nominating him”. This structure places emphasis on the role of the nominee director towards the company as such director is being remunerated for services performed to the company, and thereby buttresses the position that nominee directors owe their duties to the company. As regards stock options, the new amendments also proscribe the practice of nominee directors turning over their fees or remuneration to the nominating institutions. In that sense, the nominating institutions exercise their powers at the time of nomination (in terms of determining which individual they nominate on boards). After such appointment, the principal legal relationship is that between the nominee director and the company.

While the position of the nominee director continues to be a matter of debate, this amendment introduced by SEBI resolves the matter at least so far as grant of stock options to such directors is concerned.

(Note: The recent amendments also bring the accounting treatment prescribed by SEBI, for options granted under graded vesting, in line with the accounting treatment provided by the Institute of Chartered Accountants of India (ICAI) in this regards.)

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