Tuesday, August 14, 2012

IPO Lock-in on ESOP Shares


SEBI recently issued an informal guidance to clarify that in the case of an IPO only shares held by employees of the company or other qualifying group entities (such as a holding company) are entitled to exemption from the one-year lock-in period on pre-existing share capital. Specifically, employees who are no longer in employment of the company at the time of the IPO would be subject to the one-year lock-in even though they received shares upon exercise of employee stock options (ESOPs) granted to them while in employment.
A request for informal guidance was made by MCX Exchange to SEBI. It had two ESOP plans under which shares were allotted to its employees and that of its holding company Financial Technologies India Limited (FTIL) (which subsequently ceased to be the holding company). The request specifically pertained to the interpretation of Regulation 37 of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (the “SEBI Regulations”) that imposes a one-year lock on all pre-existing share capital of a company undertaking an IPO, where one of the exemptions relates to equity shares allotted to employees under ESOP schemes. What is determinative is the definition of “employee” and whether that includes past employees. The specific questions raised for SEBI’s guidance were as follows:
- Whether the employees of the Company who have received shares pursuant to the ESOP schemes and who have ceased to be the employees of the Company as on the date of the allotment of shares pursuant to the IPO would be considered as “employees” for the purposes of exemption from the one year lock-in under proviso (a) to Regulation 37 of the SEBI Regulations;
- Whether the existing employees and ex-employees of FTIL, which was an erstwhile holding company of the Company, who had received shares pursuant to ESOP 2006, would be considered as “employees” for the purposes of the exemption from the one year lock-in under proviso (a) to Regulation 37 of the SEBI Regulations[.]
SEBI, in its informal guidance letter, answered both questions in the negative. After examining the definition of “employee” in Regulation 2(1)(m), it observed:
As per the above definition, any person who ceased to be in the employment of the company as on the date of allotment of shares pursuant to the IPO is not considered as employee and hence the shares held by them would not be considered for the purpose of exemption from one year lock-in ... In other words, such shares held by ex-employees have to be locked in ...
This is consistent with SEBI’s previous informal guidance on a similar issue relating to Firstsource Solutions Limited, which was approach advanced by MCX in the present case.
As for the second issue, SEBI observed as follows:
The definition of the ‘employee’ under Regulation 2(1)(m) as discussed above, covers employees of the issuer, holding company, subsidiary or material associate of the issuer and director of the issuer. Accordingly, the employees and ex-employees of FTIL (which is a[n] erstwhile holding company of the issuer) would not be considered as ‘employees’ for the purpose of exemption from one year lock-in ...
This might appear to be somewhat harsh to the ex-employees of the company, but there is some rationale as it is the continued employment that confers the benefit of free transferability without lock-in. However, the continuing employees of the erstwhile holding company suffer an even harsher situation as the change in their position is not on account of any matter within their control, but due to corporate restructuring that severs the parent-subsidiary relationship between their employer and the issuer.

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